Pierson M. Grieve former CEO of Ecolab, Inc heard from the Tax Court earlier this month and the news was good. Judge Kerrigan pretty well knocked out a deficiency notice for a 2013 gift tax and penalty of over $5,000,000. It is a family limited partnership valuation decision – somewhat more fun than watching paint dry.
About Pierson M. Grieve
I think Pierson Grieve who led Ecolab from 1983 to 1995 may be one of the least controversial CEOs ever. I kept digging, but it was all pretty boring.
There was some controversy from his time on the Minnesota Metropolitan Airport Commission. Reported in the July 17, 1998 Star Tribune is an account of the dispute over the awarding of the shoe shining franchise. Over 1,000 people signed a petition supporting the incumbent who was threatened with displacement and the NAACP got involved.
The Wall Street Journal in a 1998 story indicated that his successor seemed to have a much harder time.
“Mr. Grieve was a strait-laced executive who spent much of his time plotting strategy with top subordinates and pursuing traditional CEO activities such as serving on corporate boards and high-profile community projects.”
What brought Mr. Grieve to Tax Court was his estate plan.
Family Limited Partnerships
The case was about valuation discounts on gifts of family limited partnership interests. FLP discounts are one of those things that indicate intellectual integrity is not always that useful in doing tax planning. I haven’t figure out how to work that into Reilly’s Laws of Tax Planning yet.
You take $10 million dollars worth of something and put it in a limited partnership. The limited partnership interests have all sorts of restrictions on marketability and control and the like. So now 10% of $10 million of underlying assets is worth maybe $650,000 when you give it to the natural objects of your bounty.
It Works
It really should not work, but it does, so in the right circumstances I would recommend it. The big caution is that you have to respect the entity and not just treat the partnership as if it were a personal pocketbook. Often when a FLP discount is disallowed, it has been from the parties not treating the entity with enough respect.
I explained this in some detail at the very dawn of my career as a tax writer. FLP cases are the source of Reilly’s Fourth Law of Tax Planning – Execution isn’t everything, but it’s a lot.
Given Mr. Grieve’s record as a CEO, it is not surprising that execution was not an issue in this case, particularly since his daughter Margaret Grieve who was deeply involved is a lawyer in the financial industry. Instead the IRS ventured an intriguing valuation theory and was pretty well shot down by Judge Kerrigan.
Transaction Background
The Grieve Family Limited Partnership was formed during Mr. Grieve’s Ecolab days. The general partner was the Pierson M. Grieve Management Corp (PMG). Over the years Margaret became more and more involved in managing the family wealth. In 2008, she purchased PMG for $6,200.
So Ms. Grieve owns 100% of PMG and has also been running the family office for no compensation. PMG had a controlling interest in $70 million in closely held entities. Also there was quite a bit of very low basis Ecolab stock, although from the decision it is not really clear how that was owned.
The New Plan
The very simplified version is that two new entities were formed Rabbit LLC and Angus LLC again with PMG as the general partner. Rabbit was stuffed with about $9.1 million in assets. And because of the terms of the agreement 99.98% of that was worth $5.9 million. Silly Rabbit. Angus had $32.0 million. 99.98% of that is worth about $20 million.
The Rabbit interest went to a Grantor Retained Annuity Trust which called for two payments and the Angus interest was exchanged for a life annuity worth $8.0 million according to the tables. That transaction was intended to be a taxable gift. Total gifts for 2013 were $9,996,659.
There is an interesting note as to how using a GRAT cuts the risk of the transaction.
“The parties stipulated that petitioner will not owe additional gift tax if we determine that he understated the initial fair market value of assets transferred to the GRAT if, within a reasonable time, the GRAT pays to petitioner, or to his personal representative in the event of his passing, an amount equal to the difference of the properly payable annuity and the annuity actually paid.”
The Appraisals
Grieve’s appraiser argued for a 34.97% discount on the Rabbit interest and 35.68% on the Angus interest. The discounts come from three factors. There is lack of control. There is lack of marketability. The third factor is a little more difficult. The interest is valued both on its net assets and on the income approach and the two approaches are averaged.
The IRS appraiser took what I believed was a novel approach. He assumed that a buyer of the limited partnership interest would pay a premium to also acquire the general partnership interest which on a net asset value approach would be worth less than $20,000 in the case of Rabbit and less than $50,000 in the case of Angus. So the discount was based on the premium that would have to be paid to take out the general partner. He further posited that this would be a fairly low amount relative to the assets – in the $500,000 range.
The argument went nowhere.
“Margaret, the sole owner of the class A units, testified that she had no intention of selling the units. She further testified that if she ever sold the units she would demand a premium much higher than what was estimated in the Mitchell reports. If the class B units were ever sold outside the family, Margaret explained that she would require that she be paid a management fee.”
“Elements affecting the value that depend upon events within the realm of possibility should not be considered if the events are not shown to be reasonably probable. The facts do not show that it is reasonably probable that a willing seller or a willing buyer of the class B units would also buy the class A units and that the class A units would be available to purchase.”
There are some other details, but basically the discounts claimed by the taxpayer are upheld.
“Therefore, we adopt the above-described valuations and lack of control discounts of 13.4% and 12.7% for Rabbit and Angus, respectively, and lack of marketability discounts of 25% for Rabbit and Angus.”
A Simple-Minded View
I really don’t think that these sorts of shenanigans should work. They are really indicative of my view that the true purpose of estate and gift taxes is a sort of white-collar jobs program that transfers a small amount of wealth from the upper class to the upper-middle class.
All the assets net of the annuity payments were pushed down to the next generation. The whole cannot be worth less than the sum of the parts. One approach would be to reflect whatever value is taken as a discount on the limited interests as an indirect gift to Margaret. Another approach would be to just use net assets, since it remains all in the family and the transactions appear to be overwhelmingly motivated by tax concerns.
On the other hand, if I were blessed with a fortune well in excess of $10,000,000, I would probably do something like this, although my kids would probably screw it up. Don’t get me started. Reilly’s First Law of Tax Planning – It is what it is. Deal with it.
Other Coverage
Law360 has Tax Court Sides With Ex-Ecolab CEO In $5M Gift Tax Dispute.
Stout.com had the intriguing IRS’ Game Theory Argument Gets Torpedoed by Expert’s Hot Tubbing. Apparently the IRS argument has been floating around for a while.
“The IRS’ expert used a completely different valuation approach, but one that many in the valuation industry have been exposed to vociferously by the IRS in the past. As a matter of fact, it is less of a valuation approach, more of a theoretical construct. The IRS’ argument (summarized for simplicity) is that under the game theory argument, a rational investor would not part with his 99.8% interest at a large discount if he could alternatively approach the 0.2% interest holder who has all the voting power and acquire their interest.”
Their takeaway from the decision is quite practical.
“For the time being, a combined discount of 35% for entities holding primarily cash and public stock is an excellent and appropriate result, when pitted against the theoretical construct of the game theory premium acquisition approach resulting in a 1.5% discount.”
Lew Taishoff had Possible, Not Reasonably Probable and analyzes things in his unique style.
“Pierson’s expert valuer applies some discounts to lack of control and lack of marketability, but IRS’ expert says those only applies if the willing buyer doesn’t also buy out the minority member’s 0.2% interest, and works up a premium to entice the minuscule minority to sell.
Except the minuscule minority is the same tax lawyer daughter who manages the portfolio for no fee, but says she’d charge any incoming buyer through the left nostril for her valuable services, and anyway swears she wouldn’t sell nothing never nohow.”
Coronavirus Note
I started this piece before the enormity of the crisis we are in registered. It happens that Kelly Erb has been covering the tax implications and developments masterfully and I also see Tony Nitti is weighing in. So I will just plod along with my normal coverage unless I have something different to add.
I have to say that the next time this sort of thing happens if you can arrange to be in an RV touring the southwest, you will find that it is minimally disruptive-so far. My home is in Massachusetts and I grew up near New York City, so I have people worrying about me because I am so old, while I worry about them.