by Kevin E. Hines, CPA, MST, CVA, CSEP, Partner with Meyers Brothers Kalicka, P.C
Recently, the Internal Revenue Service has been having success in winning large estate tax increases through audits of FLPs. There have been a number of court cases that have been decided in favor of the IRS. On the other hand, the taxpayers have won their fair share of cases too. The taxpayer victories have come in situations where the FLP was formed with good sound business reasoning and operated according to partnership agreements. FLPs do have a place in estate planning and possibly should be in your arsenal of estate planning tools.
An FLP is not for everyone however. There are costs associated with the FLP (set-up, annual administration, business valuations, and gift tax returns). An FLP should be considered a long-term program that should outlive the first generation (Mom and Dad). Therefore, under current estate tax law, as a starting point, an FLP may be considered by families with estates exceeding $5-6 million of family net worth.
Purpose of the FLP
Although a primary reason for using an FLP might be the reduction of Estate and Gift transfer taxes due to the IRS’s recognition of discounts from Fair Market Value for the lack of marketability or control of the investments, there should be other nontax purposes to validate the formation of the partnership. These purposes/benefits should include one or more of the following:
- Family business/investment succession planning.
- Common Management of assets.
- Diversification of investments.
- Management during seniors’ lifetime and thereafter.
- Creditor protection / Spendthrift protection.
Planning Tip – When forming the FLP think “long-term”. What if the estate tax were repealed, would there still be a purpose for the FLP?
Do’s and Don’ts of FLP
Operation of the FLP is key (in addition to the business purpose of the entity) in order to withstand a challenge from the IRS. Here are some of do’s and don’ts to formation and operation of a FLP.
- Provide for plan of succession from the senior generation.
- Minor partners should contribute their own property. Use prior gifts from senior generation.
- Senior generation should retain liquid assets individually to meet their personal needs. Don’t transfer all of the senior generation’s assets nor the primary residence.
- Do not commingle personal and FLP assets.
- Ensure that distributions follow the operating agreement and are in proportion to ownership.
- Prepare management reports and distribute them to all members.
- Do not form an FLP if senior generation is in poor health.
- Do not terminate the FLP shortly after the death of a senior member.
If you feel that you may be a candidate for a Family Limited Partnership, consult with your tax accountant or attorney to guide you forward.
This article was written by Kevin E. Hines, CPA, MST, CVA, CSEP, Partner with Meyers Brothers Kalicka, P.C., with specialties in Business Valuations, Estate Planning and Taxes.