However, the Internal Revenue Service appears to be willing to challenge this strategy in court, according an article in the Wall Street Journal, which highlighted a U.S. Tax Court case where the IRS fought the passing down of portfolios of publicly traded securities at a large discount.
How It Works
An FLP is typically established by a married couple who own a business or securities expected to rise in value over time. They wish to pass these assets to their children without incurring a large tax burden on their estate. In creating the FLP, the couple acts as general partners and "gifts" limited partner interests to their children. In doing so, these gifts are removed from the couple's estate for estate-tax purposes, even though the couple keeps control over the assets.
IRS rules say a "partnership" must serve a legitimate business interest. But attorneys have argued that the definition of partnership is wide enough to encompass family involvement in investment decisions related to a security portfolio.
Language in the current tax code supports discounts for lack of control and marketability. But the law doesn't lay down the degree of acceptable discounts, and disagreements between taxpayers and the IRS over the amount often wind up in Tax Court.
In our experience, the kinds of clients that have been a good fit for creating an FLP typically had assets worth more than the current estate tax exemption limit and they'd already blown through their lifetime gift-tax threshold. However, these clients also still wanted or needed to make additional gifts during their lifetime to reduce the size of their estate.
The point of this strategy, the WSJ says, is that the combined value of the limited-partner interests can be reduced in an evaluation by an appraiser from the value of the underlying assets, which results in a lower tax bill. The combined value is lower because limited partners don't control the assets and their individual interests are less marketable than the underlying assets.
Passing down tax-saving discounts to heirs is a big appeal for these kinds of clients. The typical discount range for securities held by such partnerships is 30-38 percent, according to the WSJ article. Lowering the discounts could affect families with "balance sheets dominated by highly liquid assets."
What Happened?
Last year, the estate of someone with a partial interest in a $52 million portfolio of government bonds and blue-chip stocks fought the IRS over the discount in Tax Court, the WSJ reported. The estate's original appraisal put the discount at 70 percent of the underlying $10.4 million market value. The court decided on a $6.5 million valuation, which was a discount of 38 percent.
A new limit on such discounts could weaken the effect of an estate planning strategy often used by clients who have already exhausted tax exemptions for gift giving during their lifetimes.
With the IRS' action in the case described above, there's a risk that the subsequent court ruling could be broadly interpreted to inhibit discounts on other assets, including family-owned businesses.
What Can You Do?
It's difficult to say if this one case may require a complete overhaul of a business-owning client's estate plan. However, it's worthy of consideration and discussion.
Talk to us. If you suspect you or your business owner clients are at risk in this issue or any others, contact our office for a consultation and review.
To learn more about common estate planning issues, check out our free guide, Estate Planning Pitfalls: The 12 Most Common Threats to Your Estate & Your Family's Future, or to discuss your estate planning concerns, please call our office at 919-443-3035 or use our contact form.
