The Family limited partnership (“FLP”) has become an increasingly useful tool for planning larger estates. The FLP also has drawn plenty of attention from the Internal Revenue Service in recent years. Usually an FLP is created by an individual and his or her spouse (often parents) transferring assets to a newly created partnership in exchange for all of the partnership interests. To maximize the benefits from an estate planning perspective, the parents will retain a small percentage as a general partner, 1% for example, and retain the remaining 99% interest as a limited partner. So far all we have done is change the nature of the assets from being held by individuals to being held by a partnership. In general, such a transfer of assets is tax-free to both the individual and the partnership.
The parents will gain estate tax benefits once they begin to give away the limited partnership interests, usually to the children. Since the limited partners have no voice in the management of the partnership, the interest qualifies for what is known as a minority discount for valuation purposes. Similarly, since there is no readily available market for an interest of this nature, a lack of marketability discount also applies. Both discounts allow the parent to make gifts of the original assets at a reduced value for gift tax purposes. This would not have been possible if the assets were merely transferred outright to the children, in which event the assets would have to be valued at their full market value.
While a gift of a limited partnership interest generally is subject to gift tax, the tax may be avoided with careful planning. A parent may transfer interests of up to $10,000 to each child annually ($20,000 if gift splitting is elected with the spouse) without any gift tax consequences. If the gift is in excess of the annual exclusion, the applicable credit of $650,000 ($675,000 in 2000) may be used. Depending on the circumstances of the donor, it may be beneficial to make a large gift up front, followed by a series of smaller gifts.
The area under heavy IRS attack is the extent of the discount used to determine the reduced value of the gift. In a 1999 IRS Field Service Advice, issued to assist field agents, the IRS advises that it will disregard restrictions in a partnership agreement and look at the nature of the assets contributed to the partnership to determine which of the assets were marketable securities. By doing so, the Service would disallow the minority and marketability discounts in valuing the transferred partnership interests.
In recent years proposals have come before Congress to disallow the use of FLPs; however, these proposals have not been adopted, and FLPs still provide us with a useful estate planning tool. Currently, the IRS is holding hearings to provide additional guidance on valuing and reporting discounts in connection with FLPs; a final report is expected to be issued by the end of this year.
Are FLPs too risky in light of today’s battles with the IRS? Not with the right ammunition. One key to a successful FLP is the utilization of qualified appraisers. With careful planning an FLP can reduce the value of your taxable estate without any significant loss of control over your assets.
The parents will gain estate tax benefits once they begin to give away the limited partnership interests, usually to the children. Since the limited partners have no voice in the management of the partnership, the interest qualifies for what is known as a minority discount for valuation purposes. Similarly, since there is no readily available market for an interest of this nature, a lack of marketability discount also applies. Both discounts allow the parent to make gifts of the original assets at a reduced value for gift tax purposes. This would not have been possible if the assets were merely transferred outright to the children, in which event the assets would have to be valued at their full market value.
While a gift of a limited partnership interest generally is subject to gift tax, the tax may be avoided with careful planning. A parent may transfer interests of up to $10,000 to each child annually ($20,000 if gift splitting is elected with the spouse) without any gift tax consequences. If the gift is in excess of the annual exclusion, the applicable credit of $650,000 ($675,000 in 2000) may be used. Depending on the circumstances of the donor, it may be beneficial to make a large gift up front, followed by a series of smaller gifts.
The area under heavy IRS attack is the extent of the discount used to determine the reduced value of the gift. In a 1999 IRS Field Service Advice, issued to assist field agents, the IRS advises that it will disregard restrictions in a partnership agreement and look at the nature of the assets contributed to the partnership to determine which of the assets were marketable securities. By doing so, the Service would disallow the minority and marketability discounts in valuing the transferred partnership interests.
In recent years proposals have come before Congress to disallow the use of FLPs; however, these proposals have not been adopted, and FLPs still provide us with a useful estate planning tool. Currently, the IRS is holding hearings to provide additional guidance on valuing and reporting discounts in connection with FLPs; a final report is expected to be issued by the end of this year.
Are FLPs too risky in light of today’s battles with the IRS? Not with the right ammunition. One key to a successful FLP is the utilization of qualified appraisers. With careful planning an FLP can reduce the value of your taxable estate without any significant loss of control over your assets.
– Leslie Heffernen