For many years, family limited partnerships (FLPs), and more recently Family Limited Liability Companies, have been a popular estate planning tool, in part due to their tax benefits. Specifically, they can allow you to transfer assets to your children (and other family members) at discounted values for gift tax purposes. The gifts may even be tax-free if you apply your lifetime exemption or annual exclusion.
However, the IRS recently proposed regulations under Section 2704 of the Internal Revenue Code that, if finalized, would limit the effectiveness of FLPs for reducing the taxable value of transferred interests.
FLP in action
To execute an FLP strategy, you contribute assets — such as marketable securities, real estate and private business interests — to a limited partnership. In exchange, you receive general and limited partner interests.
Over time, you gift, sell or otherwise transfer interests to family members and anyone else you wish (even charitable organizations). For gift tax purposes, the limited partner interests may be valued at a discount from the partnership’s underlying assets because limited partners can’t control the FLP’s day-to-day activities and the interests may be difficult to sell.
This can provide substantial tax savings. For example, under federal tax law, you can exclude certain gifts of up to $14,000 per recipient each year without depleting any of your lifetime gift and estate tax exemption. So, if discounts total, say, 30%, in 2016 you can gift an FLP interest that’s worth as much as $20,000 before discounts (based on the net asset value of the partnership’s assets) tax-free because the discounted fair market value doesn’t exceed the $14,000 gift tax annual exclusion.
An FLP must be established for a legitimate business purpose, such as efficient asset management and protection from creditors, to qualify for valuation discounts. Family Partnerships or Family Limited Liability Companies set up exclusively to minimize gift and estate taxes won’t pass IRS muster. Furthermore, we recommend appraisals from qualified appraisers to substantiate the amount of the discounts to be applied to the gifts.
Time is of the essence
If you’ve been considering using an FLP, you may need to act soon to take advantage of current tax provisions in the event the rules change. Contact us to learn more about FLPs and how the proposed regs may affect them.