The New York Times recent article "Partnerships May Aid Your Estate, But The I.R.S. Is Watching" is a short but interesting read for those interested in how family limited partnerships are used to reduce the size of an estate for tax purposes and how the I.R.S treats them. Family limited partnerships can help keep family interests in sync after death and protect their estate from a high tax bill, but the government wants to make sure they operate as true businesses, not solely to avoid estate taxes.
Apart from other business reasons, family limited partnerships are often used to reduce the size of an estate for tax purposes. What makes them attractive is that the value of whatever is in the partnership — buildings, a business, publicly traded stock — can be discounted because selling shares in a partnership to outsiders is difficult since all the partners are related.
The article addresses whether or not a family limited partnership stand up to the I.R.S. test. The article is a basic summary of a complex area of law. The article suggests discussing five basic issues.
1. WHY DID YOU SET IT UP? Do you have a legitimate business interest beyond lowering estate taxes because you can discount the value of the assets in them? If it is solely estate tax discount driven, there could be a problem with the I.R.S. Examples of legitimate business interests are (a) jointly managing the collective wealth of a family to gain access to better managers, and (b) operating an illiquid asset like a family business or a portfolio of buildings. The article notes that a "family can also use a partnership as a stealth prenuptial agreement since all the assets are wrapped up in the partnership and not easily dividable."
2. DID YOU DISCOUNT THE PARTNERSHIP TOO DRASTICALLY?
If you discounted the value of the partnership too drastically, the I.R.S. may not agree. The article quoted one expert that "the I.R.S. had seemed to settle on a discount of 25 percent in cases it had litigated." One problem noted in the article is that the I.R.S. has not given strict guidance on what you can and cannot do.
3. WHEN DID YOU SET IT UP? Was the partnership set up on a parent's deathbed? This could draw scrutiny. The Times cited one case involving the $10 million estate of Albert Strangi, a Texan who made his money in manufacturing and was in declining health when his son-in-law moved nearly all his assets into a family limited partnership. After seven years of litigation, the federal courts ruled that the partnership had been set up solely to avoid estate taxes. With such an I.R.S. ruling, the whole amount could be deemed a taxable gift. This Texas case is an extreme example, but it helps point out that timing as well as intent count.
4. HOW DO YOU MAINTAIN IT? For a family limited partnership to seen as legitimate, it needs to be run as a true business. This means regular meetings and audits as well as professional distributions. If you fail to do this, it can invite I.R.S. attention.5. WHAT DO YOU DO WITH IT? Beyond tax reasons, many partnerships are set up out of a legitimate interest to keep families together after the parents die. But this is not always what the heirs want, particularly when they do not like one another. A partnership can be unwound, but how easily depends on how it was set up and cared for.
Many of the problems described above could be avoided by talking to lawyers at the formation and over regularly time periods to see if the partnership is being run properly. For example, during the formation stage it would be a good idea to address the issue of succession. Partnerships can be a useful estate planning tool but clients need to be very careful about how they’re setting up partnerships. The devil is really in the details.”
Posted by Henry (Hank) J. Moravec, III, a partner at Moravec, Varga & Mooney. For a complimentary 30 minute consultation (telephonic or in person), you can e-mail Hank Moravec at hm@moravecslaw.com or call him at (626) 793-3210 or (818) 769-4221.
Mr. Moravec is a very experienced Los Angeles estate planning attorney, Los Angeles trust attorney and Los Angeles tax attorney. He has more than 20 years' experience in estate planning and is extremely dedicated to his clients and helping them create a plan that is tailored to their wishes, finances, helps avoid probate and taxes, and takes into account their families' unique situation.
He focuses his practice on Estate Planning, Trust and Probate Administration, Beneficiary and Trustee Representation, Probate Litigation, Tax Law, and Nonprofit Law. He represents clients throughout Southern California and his offices are conveniently located for clients in the Los Angeles, Orange, Santa Barbara, Riverside and San Bernardino Counties.
The firm website is http://www.moravecslaw.com/. The firm has two offices and consultations and meetings can be held at either office.
The San Gabriel Valley office is located at 2233 Huntington Drive, Suite 17, San Marino, California 91108. Telephone: (626) 793-3210.
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