                         115 T.C. No. 36



                     UNITED STATES TAX COURT



                  INA F. KNIGHT, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent


                HERBERT D. KNIGHT, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 11955-98, 12032-98.1      Filed November 30, 2000.

          On Dec. 28, 1994, Ps established a trust of which
     P-H was trustee (the management trust), a family
     limited partnership (the partnership) of which the
     management trust was the general partner, and trusts
     for the benefit of each of Ps' two adult children (the
     children’s trusts). Ps transferred three parcels of
     real property used by Ps and their children and some
     financial assets to the partnership. Each P
     transferred a 22.3-percent interest in the partnership
     to each of their children’s trusts.

          The parties stipulated that the steps to create
     the partnership satisfied all requirements under Texas



     1
        These cases were consolidated for trial, briefing, and
opinion.
                                 - 2 -

       law, and that the partnership has been a limited
       partnership under Texas law since it was created.

            Held: We recognize the partnership for Federal
       gift tax purposes.

            Held, further, the value of each of Ps’ gifts to
       their children’s trusts in 1994 was $394,515; i.e.,
       22.3 percent of the value of the real property and
       financial assets Ps transferred to the partnership,
       reduced by minority and lack of marketability discounts
       totaling 15 percent.

            Held, further, sec. 2704(b), I.R.C., does not apply to
       this transaction. See Kerr v. Commissioner, 113 T.C. 449
       (1999).

       William R. Cousins III, Robyn A. Frohlin, Todd Allen Kraft,

Robert M. Bolton, Robert Don Collier, and John E. Banks, Jr., for

petitioners.

       Deborah H. Delgado, Gerald Brantley, and James G. MacDonald,

for respondent.


       COLVIN, Judge:   In separate notices of deficiency sent to

each petitioner, respondent determined that each petitioner has a

gift tax deficiency of $120,866 for 1994.

       Petitioners formed a family limited partnership called the

Herbert D. Knight Limited Partnership (the partnership), and gave

interests in it to trusts they established for their children.

After concessions, the issues for decision are:

       1.   Whether, as respondent contends, the partnership is

disregarded for Federal gift tax purposes.    We hold that it is

not.
                                   - 3 -

       2.    Whether, as petitioners contend, the fair market value

of petitioners’ gifts is the value of the assets in the

partnership reduced by portfolio, minority interest, and lack of

marketability discounts totaling 44 percent.      We hold that

discounts totaling 15 percent apply.

       3.   Whether the fair market value of each of petitioners’

gifts to each children’s trust on December 28, 1994, is $263,165

as petitioners contend, $450,086 as respondent contends, or some

other amount.     We hold that it is $394,515.

       4.    Whether section 2704(b) applies.    We hold that it does

not.

       Unless otherwise indicated, section references are to the

Internal Revenue Code.     Rule references are to the Tax Court

Rules of Practice and Procedure.      References to petitioner are to

Herbert D. Knight.     References to Mrs. Knight are to petitioner

Ina F. Knight.

                           FINDINGS OF FACT

       Some of the facts have been stipulated and are so found.

A.     Petitioners

       1.    Petitioners’ Family

       Petitioners were married and lived in San Antonio, Texas,

when they filed their petitions and at the time of trial.        They

have two adult children, Mary Faye Knight (Mary Knight) and

Douglas Dale Knight (Douglas Knight).      Petitioners’ children were
                                 - 4 -

not married, and petitioners had no grandchildren at the time of

trial.     Petitioner worked for Luby's Cafeterias for 49 years and

retired at age 65 on December 31, 1992, as a senior vice

president.    In 1992, Douglas Knight was 40, and Mary Knight was

33.   By December 1994, petitioners owned assets worth about $10

million, most of which was Luby's Cafeterias stock.      Petitioners

were both in excellent health at the time of trial.

      2.    Petitioners’ Real Property

      In 1861, petitioner’s great-grandfather bought a 290-acre

ranch (the ranch) in Freestone County, Texas, about 120 acres of

which is pasture.    Knight family members are buried in a cemetery

on the ranch.    Petitioner was raised on the ranch.    By 1959,

parts of the ranch were owned by several members of petitioner’s

family.    In 1959, petitioner began to buy parts of the ranch for

sentimental reasons.    Petitioner generally has 55 to 75 cattle on

the ranch.    The ranch has never been profitable while petitioner

owned it.

      Petitioners bought their family residence at 6219 Dilbeck in

Dallas, Texas, on June 1, 1973.    Petitioners moved to San Antonio

in 1981.    Douglas Knight lived at 6219 Dilbeck rent-free from

1984 to the date of trial.    Petitioners bought a residence at

14827 Chancey in Addison, Texas, on May 12, 1993.      Mary Knight

has lived there rent-free from 1993 to the date of trial except

from November 1995 to September 1997.
                                   - 5 -

     Petitioner managed the ranch and the houses before December

28, 1994.     Petitioner paid the real estate taxes and insurance on

those properties before December 28, 1994.

B.   The Partnership

     1.      Initial Discussions

     Robert Gilliam (Gilliam), a certified public accountant, met

petitioner in the 1970's while Gilliam was auditing Luby’s

Cafeterias.     Petitioners became Gilliam’s tax clients in 1992 or

1993.     Gilliam and petitioner discussed estate planning in 1993

and 1994.

     Gilliam knew that petitioners had about $10 million in

assets.     Gilliam and petitioner discussed the fact that, if

petitioners did no estate planning, Federal transfer taxes would

equal 50 to 55 percent of their estate.      Gilliam and petitioner

discussed the tax benefits of estate planning.      Gilliam told

petitioners that they could claim discounts for transferred

limited partnership interests if supported by a professional

appraisal.     Gilliam believed that petitioners could form a trust

to help protect their assets from creditors and that a limited

partnership would add another layer of protection for those

assets.

     Petitioner sought estate planning advice from John Banks,

Jr. (Banks), in 1993 or 1994.      Banks had been petitioners’

attorney since 1981.     Petitioners met with Gilliam or Banks
                               - 6 -

several times in November and December 1994.   Late in 1994,

Gilliam and Banks devised and helped to implement an estate plan

for petitioners using a family limited partnership and related

trusts.

     2.   Implementing the Plan

     On December 6, 1994, petitioner opened an investment account

at Broadway National Bank in the name of petitioners’ family

limited partnership, the Herbert D. Knight limited partnership

(created on December 28, 1994, as described below), and

transferred Treasury notes to it.   On December 12, 1994,

petitioners opened a checking account for their partnership at

Broadway National Bank and transferred $10,000 to it from their

personal account.   On December 15, 1994, petitioners transferred

$558,939.43 worth of a USAA municipal bond fund from their

personal investment account to the partnership.

     On December 28, 1994, the following occurred:

     a.   Petitioners signed documents which created the

partnership, consisting of 100 units of ownership.   The steps

followed in the creation of the partnership satisfied all

requirements under Texas law to create a limited partnership.

     b.   Petitioners conveyed the ranch and the real property at

6219 Dilbeck and 14827 Chancey to the partnership.

     c.   Petitioners created the Knight Management Trust

(management trust).   The steps followed in the creation of the
                                - 7 -

management trust satisfied all requirements under Texas law to

create a trust.    The management trust was the partnership’s

general partner.

     d.   Petitioners each transferred a one-half unit of the

partnership to the management trust.    That unit is the only asset

held by the management trust.    Petitioners each owned a 49.5-

percent interest in the partnership as limited partners.

     e.   Petitioners created trusts for Mary Knight and Douglas

Knight (the children’s trusts).    The documents petitioners

executed were sufficient under Texas law to create the children’s

trusts.   Douglas Knight and Mary Knight were each the beneficiary

and trustee of the children’s trust bearing their name.

     f.   Petitioners each signed codicils to their wills in

which they changed the bequests to their children to bequests to

the children’s trusts.

     g.   Petitioners each transferred a 22.3-percent interest in

the partnership to each of the children’s trusts.    After those

transfers, petitioners each retained a 4.9-percent interest in

the partnership as limited partners.

     3.   The Partnership Agreement

     The partnership has been a limited partnership under Texas

law since it was created.    Article 9 of the partnership agreement

prohibits any partner from withdrawing from the partnership or

demanding the return of any of his or her capital contribution or
                                - 8 -

the balance in that partner’s capital account.   Article 14

provides that the partnership will continue for 50 years, unless

all partners consent to a dissolution.   Under the partnership

agreement, petitioner, as trustee of the management trust, could

sell any asset or part of any asset at any time.

     The fair market values (before any discounts) of partnership

assets on December 28, 1994, were as follows:

     Freestone County Ranch (with mineral rights)        $182,251
     Residential property (6219 Dilbeck)                  166,880
     Residential property (14827 Chancey)                 145,070
     USAA municipal bond fund                             553,653
     Dreyfus municipal bond fund                          510,239
     Treasury notes                                       461,345
     Insurance policies                                    51,885
     Cash                                                  10,000
          Total                                         2,081,323

     Petitioners transferred the bond funds and Treasury notes to

brokerage accounts in the name of the partnership.   The

partnership had no liabilities and no assets other than those

listed above.   All of these assets were petitioners’ community

property before being transferred to the partnership.

C.   Operation of the Management Trust and Partnership

     1.    Operation of the Management Trust

     Petitioner has been the only trustee of the management

trust.    Petitioner decides which assets to buy and sell, pays all

partnership expenses, handles and keeps records of all

partnership transactions, and explains the transactions to the

partnership's accountants.   The management trust has never had a
                                 - 9 -

checking account.   The partnership paid the management trust

expenses, such as preparation of the trust tax returns.

     2.   Operation of the Partnership

     Petitioner signed all of the checks drawn on the partnership

checking account.   The partnership kept no records, prepared no

annual reports, and had no employees.       The children and their

trusts did not participate in managing the partnership.       The

partners or their representatives have not exchanged any

correspondence, meeting notes, or e-mail about the partnership’s

operations.   The partners never met and never discussed

conducting any business activity.    All assets and know-how came

from petitioners.

     The partnership has never borrowed or lent money, and never

conducted any business activity.    It has not bought, otherwise

acquired, or sold any notes or obligations of any entity other

than Government-backed securities.       The partnership did not

prepare annual financial statements or reports.

     3.   Partnership Assets

     Petitioner did not trade the partnership’s bond funds.         He

reinvested the partnership’s Treasury notes when they matured.

He managed these investments the same way before and after he

transferred them to the trust.    The partnership did not rent real

property to third parties.
                               - 10 -

     A substantial portion of the partnership assets (the two

houses and the ranch) was used for personal purposes before and

after petitioners formed the partnership.      Petitioners’ children

did not sign a lease or pay rent to the partnership in exchange

for living at 6219 Dilbeck and 14827 Chancey.      Petitioners’

children paid the utilities while they lived at 6219 Dilbeck and

14827 Chancey.    The partnership paid the utilities at 14827

Chancey while Mary Knight was absent from November 1995 to

September 1997.   Petitioners paid real property taxes for 1994

for the ranch, 6219 Dilbeck, and 14827 Chancey, and the

partnership paid them thereafter.    Petitioners paid property

insurance premiums for 1994 for 6219 Dilbeck and 14827 Chancey,

and the partnership paid them thereafter.      The expenses of 6219

Dilbeck and 14827 Chancey were more than 70 percent of the

partnership’s annual expenses.

     Petitioner continued to operate the ranch after he

contributed it to the partnership.      He paid no rent to the

partnership until December 1998, after the petitions in these

cases were filed.   The parties stipulated that, in December 1998,

petitioner entered into an oral pasture lease on the ranch

between himself as an individual and himself as trustee.      On

December 31, 1998, petitioner paid $1,500 to the partnership as

rent under the oral pasture lease.
                              - 11 -

D.   Federal Tax Returns

     Petitioners filed Federal gift and generation-skipping

transfer tax returns for 1994.    Both petitioners reported that

they had given a 22.3-percent interest in the partnership to each

of the children’s trusts.

     The partnership filed Forms 1065, U.S. Partnership Return of

Income, for 1995, 1996, and 1997.    The management trust and each

of the children’s trusts filed Forms 1041, U.S. Income Tax Return

for Estates and Trusts, for 1995, 1996, and 1997.

                              OPINION

A.   Contentions of the Parties

     The parties agree that the starting point for valuing

petitioners’ gifts to their children’s trusts is the fair market

value of the assets petitioners transferred to the partnership

(i.e., $2,081,323), but they disagree about which discounts

apply.

     Respondent contends that petitioners’ family limited

partnership should be disregarded for gift tax valuation

purposes.   Thus, respondent contends that the fair market value

of each of the gifts is $450,086; i.e., 22.3 percent of the fair

market value of the real property and financial assets given by

petitioners, discounted for selling expenses and built-in capital

gains.
                                  - 12 -

       Petitioners contend that the partnership must be recognized

for Federal gift tax purposes,2 and that portfolio, minority, and

lack of marketability discounts totaling 44 percent apply,

reducing the value of each of the gifts to $263,165.

Alternatively, petitioners contend that, if we do not recognize

the partnership for Federal gift tax purposes, the value of each

of the four gifts is between $429,781 and $435,291 after

application of fractional interest and transactional costs

discounts.

B.     Whether To Disregard the Partnership for Gift Tax Purposes

       Respondent contends that the partnership lacks economic

substance and fails to qualify as a partnership under Federal

law.       See, e.g., Commissioner v. Culbertson, 337 U.S. 733, 740

(1949); Commissioner v. Tower, 327 U.S. 280, 286 (1946); Merryman

v. Commissioner, 873 F.2d 879, 882-883 (5th Cir. 1989), affg.

T.C. Memo. 1988-72.3      Petitioners contend that their rights and

legal relationships and those of their children changed

significantly when petitioners formed the partnership,


       2
        Petitioners contend that respondent bears the burden of
proving that the partnership should be disregarded for lack of
economic substance. We need not decide petitioners’ contention
because our findings and analysis on that issue do not depend on
which party bears the burden of proof.
       3
        Respondent does not contend that we should apply an
indirect gift analysis. See Kincaid v. United States, 682 F.2d
1220 (5th Cir. 1982); Shepherd v. Commissioner, 115 T.C. ____
(2000); sec. 25.2511-1(h)(1), Gift Tax Regs. Thus, we do not
consider that analysis here.
                              - 13 -

transferred assets to it, and transferred interests in the

partnership to their children’s trusts, and that we must

recognize the partnership for Federal gift tax valuation

purposes.   We agree with petitioners.

     State law determines the nature of property rights, and

Federal law determines the appropriate tax treatment of those

rights.   See United States v. National Bank of Commerce, 472 U.S.

713, 722 (1985); United States v. Rodgers, 461 U.S. 677, 683

(1983); Aquilino v. United States, 363 U.S. 509, 513 (1960).         The

parties stipulated that the steps followed in the creation of the

partnership satisfied all requirements under Texas law, and that

the partnership has been a limited partnership under Texas law

since it was created.   Thus, the transferred interests are

interests in a partnership under Texas law.     Petitioners have

burdened the partnership with restrictions that apparently are

valid and enforceable under Texas law.     The amount of tax for

Federal estate and gift tax purposes is based on the fair market

value of the property transferred.     See secs. 2502, 2503.   The

fair market value of property is “the price at which such

property would change hands between a willing buyer and a willing

seller, neither being under any compulsion to buy or to sell, and

both having reasonable knowledge of relevant facts.”     See sec.

20.2031-1(b), Estate Tax Regs.; sec. 25.2512-1, Gift Tax Regs.

We apply the willing buyer, willing seller test to value the
                                - 14 -

interests in the partnership that petitioners transferred under

Texas law.   We do not disregard the partnership because we have

no reason to conclude from this record that a hypothetical buyer

or seller would disregard it.

     Respondent relies on several income tax economic substance

cases.   See, e.g., Frank Lyon Co. v. United States, 435 U.S. 561,

583-584 (1978); Knetsch v. United States, 364 U.S. 361, 366

(1960); ASA Investerings Partnership v. Commissioner, 201 F.3d

505, 511-516 (D.C. Cir. 2000), affg. T.C. Memo. 1998-305; ACM

Partnership v. Commissioner, 157 F.3d 231, 248 (3d Cir. 1998),

affg. in part and revg. in part T.C. Memo. 1997-115; Merryman v.

Commissioner, supra; Winn-Dixie Stores, Inc. v. Commissioner, 113

T.C. 254, 278 (1999).   We disagree that those cases require that

we disregard the partnership here because the issue here is what

is the value of the gift.   See secs. 2501, 2503; sec. 20.2031-

1(b), Estate Tax Regs.; sec. 25.2512-1, Gift Tax Regs.

     Respondent points out that in several transfer tax cases we

and other courts have valued a transfer based on its substance

instead of its form.    See, e.g., Heyen v. United States, 945 F.2d

359, 363 (10th Cir. 1991); Schultz v. United States, 493 F.2d

1225 (4th Cir. 1974); Estate of Murphy v. Commissioner, T.C.

Memo. 1990-472; Griffin v. United States, 42 F. Supp. 2d 700, 704

(W.D. Tex. 1998).   Our holding is in accord with those cases

because we believe the form of the transaction here (the creation
                              - 15 -

of the partnership) would be taken into account by a willing

buyer; thus the substance and form of the transaction are not at

odds for gift tax valuation purposes.   Respondent agrees that

petitioners created and operated a partnership as required under

Texas law and gave interests in that partnership to their

children’s trusts.   Those rights are apparently enforceable under

Texas law.

C.   Whether the Value of Petitioners’ Four Gifts Is Limited to
     $300,000 Each

     The transfer document through which petitioners made the

gifts at issue states that each petitioner transferred to each of

their children’s trusts the number of limited partnership units

which equals $300,000 in value.4   Petitioners contend that this

bars respondent from asserting that the value of each partnership

interest exceeds $300,000.

     Respondent contends that the transfer document makes a

formula gift that is void as against public policy.   Respondent

relies on Commissioner v. Procter, 142 F.2d 824 (4th Cir. 1944),

and Ward v. Commissioner, 87 T.C. 78, 109-116 (1986).     In

Procter, the transfer document provided that, if a court decided


     4
        The transfer document identifies petitioners as
transferors and states:

     Transferor irrevocably transfers and assigns to each
     Transferee above identified, as a gift, that number of
     limited partnership units in Herbert D. Knight Limited
     Partnership which is equal in value, on the effective
     date of this transfer, to $600,000.
                               - 16 -

a value that would cause a part of the transfer to be taxable,

that part of the transfer would revert to the donor.    The U.S.

Court of Appeals for the Fourth Circuit described this provision

as a condition subsequent, and held that it was void as against

public policy.    See Commissioner v. Procter, supra at 827.

     We need not decide whether Procter and Ward control here

because we disregard the stated $300,000 gift value for other

reasons.   First, petitioners reported on their gift tax returns

that they each gave two 22.3-percent interests in the

partnership.    Contrary to the transfer document, they did not

report that they had given partnership interests worth $300,000.

We believe this shows their disregard for the transfer document,

and that they intended to give 22.3-percent interests in the

partnership.5

     Second, even though petitioners contend that respondent is

limited to the $300,000 amount, i.e., that the gifts were for

$300,000 and thus cannot be worth more than $300,000, petitioners

contend that the gifts are each worth less than $300,000.      In

fact, petitioners offered expert testimony to show that each gift

was worth only $263,165.   We find petitioners’ contentions to be

at best inconsistent.    We treat petitioners’ contention and offer


     5
        Gifts of 22.3-percent partnership interests are at odds
with the appraisal which valued a 22.22222-percent interest at
the $300,000 amount specified in the transfer document.
Petitioners do not explain this discrepancy between the transfer
document and their returns.
                               - 17 -

of evidence that the gifts were worth less than $300,000 as

opening the door to our consideration of respondent’s argument

that the gifts were worth more than $300,000.

D.   Petitioners’ Contention That a Portfolio Discount and
     Minority and Lack of Marketability Discounts Totaling 44
     Percent Apply

     Petitioners’ expert, Robert K. Conklin (Conklin), estimated

that, if we recognize the partnership for Federal tax purposes, a

10-percent portfolio discount and discounts of 10 percent for

minority interest and 30 percent for lack of marketability apply,

for an aggregate discount of 44 percent.6

     1.   Portfolio Discount

     Conklin concluded that a 10-percent portfolio discount

applies based on the assumption that it is unlikely that a buyer

could be found who would want to buy all of the Knight family

partnership’s assets.   He provided no evidence to support that

assumption, see Rule 143(f)(1); Rose v. Commissioner, 88 T.C.

386, 401 (1987), affd. 868 F.2d 851 (6th Cir. 1989); Compaq

Computer Corp. v. Commissioner, T.C. Memo. 1999-220.

     To estimate the amount of the portfolio discount, Conklin

relied on a report stating that conglomerate public companies

tend to sell at a discount of about 10 to 15 percent from their


     6
        Respondent’s expert, Francis X. Burns, testified about
the “fair value” but not the “fair market value” of the
partnership interests at issue in these cases. We have not
considered his testimony in deciding the fair market value of the
gifts.
                               - 18 -

breakup value.    However, the Knight family partnership is not a

conglomerate public company.

     Conklin cites Shannon Pratt’s definition of a portfolio

discount7 in estimating the portfolio discount to apply to the

assets of the partnership.    A portfolio discount applies to a

company that owns two or more operations or assets, the

combination of which would not be particularly attractive to a

buyer.    See Estate of Piper v. Commissioner, 72 T.C. 1062, 1082

(1979).    The partnership held real estate and marketable

securities.    Conklin gave no convincing reason why the

partnership’s mix of assets would be unattractive to a buyer.     We

apply no portfolio discount to the assets of the partnership.

     2.     Lack of Control and Marketability Discounts

     Conklin concluded that a lack of control discount applies.

He speculated that, because the partnership invested a large part


     7
        Pratt et al., Valuing a Business, The Analysis and
Appraisal of Closely Held Companies 325 (3d ed. 1996):

     The concept of a ‘portfolio’ discount is a discount for
     a company that owns anywhere from two to several
     dissimilar operations and/or assets that do not
     necessarily fit well together. Many private companies
     have accumulated such a package of disparate operations
     and/or assets over the years, the combination of which
     probably would not be particularly attractive to a
     buyer seeking a position in any one of the industries,
     necessitating a discount to sell the entire company as
     a package. Research indicates that conglomerate public
     companies tend to sell at a discount of about 10 to 15
     percent from their breakup value, although the
     relationship is not consistent from company to company
     or necessarily over time.
                              - 19 -

of its assets in bonds, and investors in the bond fund could not

influence investment policy, the partnership “could be similar to

a closed-end bond fund”.8   He estimated that a lack of control

discount of 10 percent applies by evaluating the difference

between the trading value and the net asset values on October 21,

1994, of 10 publicly traded closed-end bond funds.   The 10 funds

that Conklin chose are not comparable to the Knight family

partnership.9   We find unconvincing his use of data from

noncomparable entities to increase the discount.   However, on




     8
        A publicly traded closed-end bond fund owns a fixed
number of bonds. The net asset value of those bonds held by a
closed-end fund is published. The value of an interest in a
closed-end fund may trade at a premium (i.e., above the net asset
value per share) or at a discount (i.e., below the net asset
value per share).
     9
        Only the Nuveen Municipal Value Fund had assets that were
comparable to the partnership. No hard and fast rule dictates
the number of comparables required, but courts have rejected use
of one comparable, see Estate of Hall v. Commissioner, 92 T.C.
312 (1989); Estate of Rodgers v. Commissioner, T.C. Memo. 1999-
129; Klukwan, Inc. v. Commissioner, T.C. Memo. 1994-402; Crowley
v. Commissioner, T.C. Memo. 1990-636, affd. on other grounds 962
F.2d 1077 (1st Cir. 1992); Higgins v. Commissioner, T.C. Memo.
1990-103; Dennis v. United States, 70 AFTR 2d 92-5946, 92-5949,
92-2 USTC par. 50,498 (E.D. Va. 1992), unless it is compelling,
see also 885 Inv. Co. v. Commissioner, 95 T.C. 156, 167-168
(1990); Estate of Fawcett v. Commissioner, 64 T.C. 889, 899-900
(1975); Clark v. Commissioner, T.C. Memo. 1978-402. The
comparability is not compelling here. First, the value of the
partnership’s interest in the two bond funds was about $1.1
million; the value of the assets in the Nuveen Municipal Value
Fund was nearly $1.9 billion. Second, 51 percent of the
partnership assets were invested in two tax-exempt municipal bond
funds; the Nuveen Municipal Value Fund held no real property.
                                - 20 -

this record, we believe some discount is appropriate based on an

analogy to a closed-end fund.

     Conklin cited seven studies of sales of restricted stocks

from 1969 to 1984 to support his estimate that a 30-percent

discount for lack of marketability applies.    He used a table

summarizing initial public offerings of common stock from 1985 to

1993.     However, he did not show that the companies in the studies

or the table were comparable to the partnership, or explain how

he used this data to estimate the discount for lack of

marketability.    See Tripp v. Commissioner, 337 F.2d 432, 434-435

(7th Cir. 1964), affg. T.C. Memo. 1963-244; Rose v. Commissioner,

supra; Chiu v. Commissioner, 84 T.C. 722, 734-735 (1985).     He

also listed seven reasons why a discount for lack of

marketability applies, but he did not explain how those reasons

affect the amount of the discount for lack of marketability.

     3.     Conklin’s Factual Assumptions

     Conklin listed 19 purported business reasons for which he

said the partnership was formed.    Petitioners claimed to have had

only 5 of those 19 reasons.10    Conklin also said: “The


     10
         Petitioners’ five reasons are: (a) Centralize control
of family investments; (b) avoid fragmentation of interests; (c)
consolidate family interests into one entity; and protect the
children’s assets (d) from creditors and (e) in the event of a
divorce.
     The 14 reasons Conklin gave but petitioners did not are:
(a) Obtain better rates of return; (b) reduce administrative
costs; (c) provide for competent management in case of death or
                                                   (continued...)
                               - 21 -

compensation and reimbursement paid to the general partner reduce

the income available to limited partners or assignees.”   His

statement is inapplicable because the general partner received no

compensation and incurred no expenses.

     We have rejected expert opinion based on conclusions which

are unexplained or contrary to the evidence.   See Rose v.

Commissioner, supra; Compaq Computer Corp. v. Commissioner,

supra.    An expert fails to assist the trier of fact if he or she

assumes the position of advocate.    See Estate of Halas v.

Commissioner, 94 T.C. 570, 577 (1990); Laureys v. Commissioner,

92 T.C. 101, 122-129 (1989).   Conklin’s erroneous factual

assumptions cast doubt on his objectivity.

     4.     Conclusion

     The parties stipulated that the net asset value of the

partnership was $2,081,323 on December 28, 1994.   Each petitioner

gave each trust a 22.3-percent interest in the partnership; 44.6

percent of $2,081,323 is $928,270.


     10
      (...continued)
disability; (d) avoid cumbersome and expensive guardianships; (e)
avoid or minimize probate delay and expenses; (f) minimize
franchise tax liability; (g) provide business flexibility because
the agreement can be amended; (h) eliminate ancillary probate
proceedings; (i) provide a convenient mechanism for making annual
gifts; (j) provide a vehicle to educate descendants about family
assets to increase their value; (k) provide a mechanism to
resolve family disputes; (l) avoid adverse tax consequences that
may occur by dissolving a corporation; (m) provide better income
tax treatment than would apply to a corporation or trust; and (n)
provide more flexibility in making investments than a trust
because of the fiduciary standard.
                             - 22 -

     We conclude that Conklin was acting as an advocate and that

his testimony was not objective.   However, despite the flaws in

petitioners’ expert’s testimony, we believe that some discount is

proper, in part to take into account material in the record

relating to closed-end bond funds.     We hold that the fair market

value of an interest in the Knight family partnership is the pro

rata net asset value of the partnership less a discount totaling

15 percent for minority interest and lack of marketability.

Thus, on December 28, 1994, each petitioner made taxable gifts of

$789,030 (44.6 percent of $2,081,323, reduced by 15 percent).

E.   Whether Section 2704(b) Applies

     Respondent contends that Article 14 (the 50-year term or

dissolution by agreement of all partners) and Article 9 (the lack

of withdrawal rights for limited partners) of the partnership

agreement are applicable restrictions under section 2704(b)

because sections 8.01 and 6.03 of Texas Revised Limited

Partnership Act (TRLPA), Tex. Rev. Civ. Stat. Ann. art. 6132a-1

(West Supp. 1993), are less restrictive.    We disagree.   See Kerr

v. Commissioner, 113 T.C. 449 (1999).

     If a transferor conveys to a family member an interest in a

partnership or a corporation which is subject to an “applicable

restriction”, and the transferor and transferor's family members

control the entity immediately before the transfer, the

restriction in valuing the interest shall be disregarded.    See
                               - 23 -

sec. 2704(b)(1).   An “applicable restriction” is a provision that

limits the ability of the partnership or corporation to liquidate

if (1) the restriction lapses after the transfer, or (2) the

transferor or any member of the transferor’s family, collectively

or alone, can remove or reduce the restriction after the

transfer.    See sec. 2704(b)(2); sec. 25.2704-2(b), Gift Tax Regs.

However, a restriction on liquidation is not an applicable

restriction if it is not more restrictive than limitations on

liquidation under Federal or State law.    See sec. 2704(b)(3).

     In Kerr, the Commissioner contended that the provisions in

the partnership agreement (50-year term or dissolution by

agreement of all partners and the lack of withdrawal rights for

limited partners) were applicable restrictions under section

2704(b) because TRLPA sections 8.01 and 6.03 were less

restrictive.    We rejected those arguments in Kerr and noted that,

under Texas law, a limited partner may withdraw from a

partnership without requiring the dissolution and liquidation of

the partnership.    See id. at 473.   We concluded that the

partnership agreements in Kerr were not more restrictive than the

limitations that generally would apply to the partnerships under

Texas law.    See id. at 472-474.   Similarly, we conclude that

section 2704(b) does not apply here.
                             - 24 -

     To reflect the foregoing,


                                        Decisions will be entered

                                   under Rule 155.



Reviewed by the Court.

     CHABOT, COHEN, PARR, RUWE, WHALEN, HALPERN, CHIECHI, GALE,
and THORNTON, JJ., agree with this majority opinion.

     LARO and MARVEL, JJ., concur in result only.
                               - 25 -

     FOLEY, J., concurring in result:    Family limited

partnerships are proliferating as an estate planning device,

taxpayers are planning amid great uncertainty, and respondent is

asserting numerous theories (i.e., economic substance, Chapter

14, section 2036, immediate gift upon formation, etc.) in an

attempt to address these transactions.   It is important that we

clarify the law in this area with a careful statement of the

applicable principles.    While I agree with the majority that the

partnership must be respected, I write separately to emphasize

two points.

I.   The “Willing Buyer, Willing Seller” Test Is Not a Relevant
     Consideration in Determining Whether a Partnership Is To Be
     Respected Under State Law

     I disagree with some of the reasoning set forth in the

majority opinion.   Specifically, the rationale set forth for

respecting the partnership is as follows:

     We do not disregard the partnership because we have no
     reason to conclude from this record that a hypothetical
     buyer or seller would disregard it.

               *     *     *    *    *    *    *

     * * * we believe the form of the transaction here (the
     creation of the partnership) would be taken into account by
     a willing buyer; thus the substance and form of the
     transaction are not at odds for gift tax valuation purposes.
     * * * [Majority op. pp. 14-15.]

     The Knight family limited partnership is a valid legal

entity under Texas law.   Even if a hypothetical buyer and seller

were to determine that the value of the partnership interest was
                                - 26 -

equal, or approximately equal, to the value of the corresponding

underlying assets,1 that would not be legal justification for

applying the economic substance doctrine and disregarding the

partnership.   Whether “the form of the transaction here (the

creation of the partnership) would be taken into account by a

willing buyer” is not a relevant consideration in determining

whether the entity must be respected for transfer tax purposes.

Our assessment of the property rights transferred is a State law

determination not affected by the “willing buyer, willing seller”

valuation analysis.   Sec. 20.2031-1(b), Estate Tax Regs. (stating

that the fair market value of property is “the price at which the

property would change hands between a willing buyer and a willing

seller”).   In essence, that analysis assists the Court in

determining the value of partnership interest after the Court

establishes whether the entity is recognized under State law.

     The determination of whether or not the partnership should

be respected is independent of the value of the partnership

interest.   The logical inference from the majority’s statements,

however, is that a partnership could be disregarded for lack of

economic substance if a hypothetical willing buyer would not

respect the partnership form.    This language may mislead

     1
        The value of the partnership interest and its
corresponding underlying assets will not be equal because
virtually any binding legal restriction will make such
partnership interest less than the value of its corresponding
underlying assets.
                               - 27 -

respondent and encourage him to proffer expert testimony in a

fruitless attempt to establish that a partnership should be

disregarded because the value of a partnership interest is equal,

or approximately equal, to the value of the corresponding

underlying assets.    The “willing buyer, willing seller” analysis

merely establishes the value of a partnership interest, not

whether the economic substance doctrine is applicable.

II.   The Economic Substance Doctrine Should Not Be Employed in
      the Transfer Tax Regime To Disregard Entities

      A fundamental premise of transfer taxation is that State law

defines and Federal tax law then determines the tax treatment of

property rights and interests.    See Drye v. United States, 528

U.S. 49 (1999); Morgan v. Commissioner, 309 U.S. 78 (1940).     As a

result, the courts have not employed the economic substance

doctrine to disregard an entity (i.e., one recognized as bona

fide under State law) for the purpose of disallowing a purported

valuation discount.

      The application of the economic substance doctrine in the

transfer tax context generally has been limited to cases where a

taxpayer attempts to disguise the transferor or transferees.    The

courts in these cases occasionally mention, but do not explicitly

incorporate, a business purpose inquiry in their analysis.    See

Heyen v. United States, 945 F.2d 359 (10th Cir. 1991)(applying

only substance over form analysis to a gift of stock to disregard
                              - 28 -
intermediate transferees); Schultz v. United States, 493 F.2d

1225 (4th Cir. 1974)(applying essentially a substance over form

analysis to reciprocal gifts); Griffin v. United States, 42 F.

Supp. 2d 700 (W.D. Tex. 1998)(discussing the lack of business

purpose inherent in gifts, and then applying economic substance

analysis to a gift of stock).

     Generally, the economic substance doctrine, with its

emphasis on business purpose, is not a good fit in a tax regime

dealing with typically donative transfers.    Business purpose will

oftentimes be suspect in these transactions because estate

planning usually focuses on tax minimization and involves the

transfer of assets to family members.    If taxpayers, however, are

willing to burden their property with binding legal restrictions

that, in fact, reduce the value of such property, we cannot

disregard such restrictions.    To do so would be to disregard

economic reality.

     WELLS, C.J., agrees with this concurring opinion.
                                - 29 -


       BEGHE, J., dissenting:   Using the estate depletion approach

set forth in my dissenting opinion in Shepherd v. Commissioner,

115 T.C. ___ (2000) (slip opinion pp. 63-67), as supplemented by

my dissenting opinion in Estate of Strangi v. Commissioner, 115

T.C.       (2000) (slip opinion pp. 39-48),   I respectfully suggest

that the valuation focus in this case should have been on the

assets transferred by the donors, rather than on the partnership

interests received by the donees.    I would have valued the gifts

at 100 percent of the values of the assets transferred to the

partnership by Mr. and Mrs. Knight, reducing the values so

arrived at by the values of the partnership interests Mr. and

Mrs. Knight received and retained.
