In recent years family limited partnerships (FLPs) have become an increasingly popular way to give assets to children. You can discount the value of assets you transfer to an FLP by 20%, 30%, or even more. The less a gift is worth in the eyes of the IRS, the more you can pass along with little or no tax liability. Thus, you can transfer an interest in a business, real estate, securities, or other holdings to your children and pay lower gift and estate taxes.
One of the key attractions to FLPs has been the ability to give away discounted interests in your assets while continuing to manage them. However, a recent U.S. Tax Court decision has called into question the ability of those who establish FLPs to retain management control.
Typically, parents establish an FLP to hold a particular asset. They serve as general partners and manage the FLP, while the children are limited partners. Because the children couldn’t easily sell their interests in this private vehicle managed by their parents, the IRS considers interests in an FLP to be worth less than the actual market value of assets it holds. So, for example, a gift of a 99% limited partnership interest in an FLP owning property worth $1.5 million might be valued at just $1 million for tax purposes.
For wealthy families with many children and grandchildren, an FLP can be a good way to move assets out of parents’ estates.
Because anyone can currently make annual tax-free gifts of up to $14,000 to an unlimited number of recipients, parents can slowly transfer assets to their family’s younger generations without paying gift tax. An FLP can also be an effective way to transfer real estate incrementally without having to file a new deed every year.
The Tax Court decision in 2003 invalidated an FLP established by Albert Strangi. The problem, the court ruled, was that Strangi, through his attorney, still had use of the assets he was transferring, and as general partner retained the right to determine who could enjoy them. The court threw the full, undiscounted value of property contributed to the FLP back into Strangi’s estate for tax purposes.
Subsequently, the decision against Strangi was affirmed by the Fifth Circuit Court.
Despite this turn of events, FLPs are still very much alive, although some concessions may have to be made. For instance, parents transferring assets to children may have to give up management control of the FLP, say estate tax attorneys. One way to do that could be to name your spouse as general partner, says Gideon Rothschild, chairman of the American Bar Association International Estate Planning Committee. But you, and not your spouse, would have to transfer the assets, Rothschild says.
Another approach would be to name a trust with an independent trustee as GP. Rothschild says that another recent court case confirmed the validity of FLPs when the transferring party didn’t retain an interest in the assets. He maintains the Strangi case doesn’t negate the benefits of FLPs; it just requires more careful crafting and a rethinking of the management structure.
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