In order to reduce your potential estate tax you must reduce your taxable estate. One customary way to reduce your estate is to make gifts to your ultimate beneficiaries such as your children and grandchildren. Removing an asset from your taxable estate by gift though, will generally require you to part with all dominion and control of the gifted asset. Gifting interests in a Family Limited Partnership which owns the assets that you wish to transfer to your beneficiaries when, properly structured, will remove the assets including appreciation (at a discounted value) from your taxable estate while allowing you to retain control of the assets.
A Family Limited Partnership (FLP) is nothing more than a traditional limited partnership with the donor and the donor’s family members as the general and limited partners. A Limited Liability Company (LLC) is synonymous with a partnership for this purpose since an LLC can be taxed as if it were a partnership. Limited partners by law have no say in the operation and management of any limited partnership which accounts for the discount in value of their partnership interest. General partners control the operation of a limited partnership regardless of their percentage of ownership.
A typical FLP might be organized and operated in the following manner. Donor transfers an asset worth $1,000,000 to a newly created FLP in exchange for a 1% general partnership interest and a 99% limited partnership interest. Donor immediately gifts the 99% limited partnership interest to his children, retaining the 1% general partnership interest. Donor dies 10 years later when the asset is worth $2,000,000. Had Donor gifted 99% of the asset directly to his children, the value of the gift would have been $999,000. Since the children have no control over the asset, the value of the gifted limited partnership interest can be discounted for gift tax purposes. Properly structured and operated it is reasonable to assume the IRS would accept a discount for lack of control and marketability of at least 35%. The value for gift tax purposes of the limited partnership interest assuming a 35% discount would be $643,500. Assuming Donor retains control of the asset until death by retaining the 1% general partnership interest, he or she has removed $1,980,000 from his or her estate at a gift tax cost of only $643,500.
The IRS and Congress have been increasingly concerned with this estate tax saving opportunity. IRS has repeatedly challenged what it believes to be the abusive use of Family Limited Partnerships. The kind of asset transferred to the FLP can be an issue. If marketable securities are the only asset, one can expect IRS scrutiny. At this point though, funding the FLP with something like a rental property appears to be safe.An IRS challenge can also be expected if the FLP fails to operate as such. For example, if the 1% general partner in our example receives distributions in excess of his or her ownership percentage, IRS can be expected to object.
The amount of minority or lack of marketability discounts continues to be an issue. A review of the case law and my personal experience leads me to feel comfortable with a combined discount of 35% when indicated by a sufficient appraisal. The courts have delineated the factors which constitute a sufficient appraisal. A potential donor would be well advised to engage an appraiser conversant with these factors.
Certain members of Congress are interested in legislating away this tax saving opportunity. The “Certain Estate Tax Relief Act of 2009” would eliminate discounts to Family Limited Partnerships as a matter of course. Nevertheless, unless this bill is passed and made retroactive, properly formed and operated, transfers to and gifts of FLP interests are an effective way to reduce estate tax while retaining control of the transferred assets. As always, an attorney well versed in these provisions should be consulted.
A Family Limited Partnership (FLP) is nothing more than a traditional limited partnership with the donor and the donor’s family members as the general and limited partners. A Limited Liability Company (LLC) is synonymous with a partnership for this purpose since an LLC can be taxed as if it were a partnership. Limited partners by law have no say in the operation and management of any limited partnership which accounts for the discount in value of their partnership interest. General partners control the operation of a limited partnership regardless of their percentage of ownership.
A typical FLP might be organized and operated in the following manner. Donor transfers an asset worth $1,000,000 to a newly created FLP in exchange for a 1% general partnership interest and a 99% limited partnership interest. Donor immediately gifts the 99% limited partnership interest to his children, retaining the 1% general partnership interest. Donor dies 10 years later when the asset is worth $2,000,000. Had Donor gifted 99% of the asset directly to his children, the value of the gift would have been $999,000. Since the children have no control over the asset, the value of the gifted limited partnership interest can be discounted for gift tax purposes. Properly structured and operated it is reasonable to assume the IRS would accept a discount for lack of control and marketability of at least 35%. The value for gift tax purposes of the limited partnership interest assuming a 35% discount would be $643,500. Assuming Donor retains control of the asset until death by retaining the 1% general partnership interest, he or she has removed $1,980,000 from his or her estate at a gift tax cost of only $643,500.
The IRS and Congress have been increasingly concerned with this estate tax saving opportunity. IRS has repeatedly challenged what it believes to be the abusive use of Family Limited Partnerships. The kind of asset transferred to the FLP can be an issue. If marketable securities are the only asset, one can expect IRS scrutiny. At this point though, funding the FLP with something like a rental property appears to be safe.An IRS challenge can also be expected if the FLP fails to operate as such. For example, if the 1% general partner in our example receives distributions in excess of his or her ownership percentage, IRS can be expected to object.
The amount of minority or lack of marketability discounts continues to be an issue. A review of the case law and my personal experience leads me to feel comfortable with a combined discount of 35% when indicated by a sufficient appraisal. The courts have delineated the factors which constitute a sufficient appraisal. A potential donor would be well advised to engage an appraiser conversant with these factors.
Certain members of Congress are interested in legislating away this tax saving opportunity. The “Certain Estate Tax Relief Act of 2009” would eliminate discounts to Family Limited Partnerships as a matter of course. Nevertheless, unless this bill is passed and made retroactive, properly formed and operated, transfers to and gifts of FLP interests are an effective way to reduce estate tax while retaining control of the transferred assets. As always, an attorney well versed in these provisions should be consulted.
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