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Previous Messages. Over the years, we have advised professionals (and now e-mail subscribers) about developments in tax treatment of family business entities, partnerships or LLC=s. These entities are usually described in the literature as FLP=s. This designation stands for AFamily Limited Partnership@. However, the same principles apply to limited liability companies - LLC=s, which are more commonly used in Michigan.
The big news for estate planners is that the IRS has issued a press release - UIL 2031.01-00 on this subject. But before we discuss the release, in brief, let=s review why this is an important subject.
Why FLP=s? Why do planners advise that assets be transferred to an FLP? We advisors often cite many tax reasons for assembling assets in a partnership or LLC. These include liability protection and centralized management. However, to get down to dollars and cents, one of the big reasons is the availability of discounts for lack of marketability and minority interests for purposes of calculating gift values or estate taxes on the transfer of FLP interests during lifetime or at death.
The most notable cases have been the estate tax cases where marketable securities have been transferred to an FLP shortly before death in exchange for FLP ownership interests. Two immediate questions are then presented:
(1) What is the value of the FLP interests owned by a decedent?
(2) Are all of the underlying assets in the FLP brought back into the taxable estate under IRC '2036 and/or '2038?
What Has Happened in These Cases? The taxpayer=s personal representative typically values the FLP interests on the federal estate tax return (Form 706) at the substantial discounts to the proportional value of the underlying assets. These discounts are known as minority interests and marketability discounts, which are taken in order and thus compounded to a certain extent. To simplify the example, if the proportionate interest of the assets, with current appraisals, is $1.0 million, the estate may claim a valuation of $600, or even less, for the decedent=s FLP interest.
What Does The IRS Say? The IRS has typically challenged almost all of these transactions on various grounds, alleging that (a) the discounts are too high; (b) the transaction was a sham; or, (c) the decedent retained enough control to bring the entire value of the assets transferred back into the taxable estate, disregarding any discounts.
Where Is The IRS Now? Because there have been so many estate tax controversies, the IRS has organized a national team to deal with all of these issues, coordinate litigation if necessary and negotiate settlements, if possible. Valuation issues and validity of the FLP questions have dominated the disputed cases that the IRS is handling.
Why Is The New Release Important? The IRS has issued guidelines to make settlement of the outstanding disputes easier. They say they will analyze whether the FLP was Areal@ at the outset. Key questions that an agent will examine are still confidential, but it is obvious from the decided cases that there are many important facts which will be reviewed, including:
(1) How soon before death was the FLP organized?
(2) Did the decedent retain enough assets to provide for living expenses for his or her remaining life expectancy?
(3) Were personal assets, such as a residence, transferred to the FLP?
(4) Were proper business formalities followed, i.e., separate tax returns, separate bank account, and accurate accounting?
(5) Were any business assets transferred, such as real estate, or were all of the assets marketable securities?
(6) Were any personal expenses of the transferor paid by the FLP?
If, under the preponderance of the evidence, the FLP was ignored or abused, the IRS says they will jump over the issue of discounts and treat the transferred assets as part of the decedent=s taxable estate under IRC '2036 and '2038. The IRS has been winning cases where the answers to the above questions and others indicate that the FLP was really a sham.
Do The Taxpayers Ever Win? The IRS Release concedes that if business formalities have been followed they will not challenge the existence of the FLP, to bring the underlying assets back to the estate under '2036 and '2038, but will negotiate on the amount of the discounts that IRS will consider in settling a case. The Release has tabulated the discounts that have been allowed in litigated cases for minority interests and lack of marketability. The IRS concedes that the tax court has become Aincreasingly sophisticated@ in reviewing appraisals. It noted that combined discounts allowed by the tax court ranged from 27% to 32%. This would indicate that these are the settlement ranges that IRS is willing to consider, if there are qualified appraisals submitted by the taxpayer. This could be very important to taxpayers who have documented their cases well and do not have the Ataints@ outlined above or others.
Are FLP=s a Lost Cause? Most knowledgeable planners have taken the position that FLP=s are not a lost cause and have advised clients that there are many non-tax benefits in using FLP=s as part of overall estate planning. These include annual gifting and transfers of business interests to family members to involve them in management roles on a gradual basis.
Many of the FLP=s that we organize and advise are part of an overall wealth management and wealth transfer plan. Annual exclusion gifts to family members are often utilized with appropriate gift tax returns and appraisals filed on an annual basis. Usually, the FLP=s that we advise involve business assets or real estate, not just marketable securities. They do not include personal residences. (Putting a personal residence into an FLP is a red flag, in our opinion.)
Conclusion. The new IRS Release is important because it indicates that the government is analyzing Ahazards of litigation@ and will probably be settling many of the pending cases, with reasonable discounts allowed.
It is also helpful, in discussing cases in which the taxpayers have lost, the factors that the IRS considers important in determining the strength of the government=s case and the corresponding weaknesses in the positions taken by taxpayers.
It is true that taxpayers have lost some cases, particularly when the existence of the FLP and the formalities of its organization have been ignored. However, we advise clients that the FLP can be a valuable entity in overall tax planning and planning for the transfer of wealth. We are still recommending that clients consider this option in their long range estate planning. On the flip side, we would advise clients of the hazards of death bed organization and failure to follow consistent business practices. If you would like to discuss the possibility of organizing an FLP or making an FLP part of your overall estate plan, please contact Jim Modrall at (231) 941-9660 or any of the other attorneys listed below.
Donald A. Brandt, Joseph C. Fisher, Thomas R. Alward, Edgar Roy, III, Matthew D. Vermetten, Thomas A. Pezzetti, Jr., John M. Grogan, Vicki P. Kundinger, Susan Jill Rice, Gary D. Popovits, Lawrence K. Kustra, H. Douglas Shepherd, Jonathan J. Siebers and Karin Church at (231) 941-9660
©BRANDT, FISHER, ALWARD & ROY, P.C.
This newsletter is provided for informational purposes and should not be acted upon without professional
advice.
| WEALTH CONSERVATION: PROFESSIONAL ALERT Brandt, Fisher, Alward & Roy, P.C. |
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| Brandt, Fisher, Alward & Roy, P.C. Attorneys at Law |
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February
2007 BIG NEWS FOR ESTATE PLANNERS - FLP GUIDELINES by James R. Modrall III, J.D., C.P.A. |