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Family Limited Partnerships have recently come into vogue, although they have been a useful estate planning tool for more than 40 years. The popularity of Family Limited Partnerships has grown primarily because of a 1993 IRS clarification specifically authorizing the ability to consider gifts of stock to family members eligible for minority discounts, states attorney Larry Hause, who specializes in estate planning for Minneapolis, Minn.-based law firm Fredrikson & Byron.

According to Hause, a Family Limited Partnership may provide significant advantages in the following areas: reducing gift taxes, reducing estate taxes, facilitating family succession and protecting assets.

In creating a Family Limited Partnership, family members (usually parents) put assets into a partnership, then give a minority interest to other family members (still retaining control of the assets). Through a Family Limited Partnership, parents can begin to shift wealth to their children, introduce them to asset management, educate them about investments and wealth, facilitate and manage pooled resources, and achieve different economies of scale.

“Children can also manage their parents’ assets through a Family Limited Partnership instead of a revocable trust,” explains Hause. “In this application, the children are the general partners and the parents are the limited partners. The parents own a greater share of the assets and thus receive most of the income stream, but the children manage the assets for the parents. Upon the parents’ death, those assets can be distributed without going through probate.”

The ability to take discounts on partnership interests in a Family Limited Partnership is a wonderful gift tax and estate tax planning tool. As with any limited partnership, the holders of a partnership interest in a Family Limited Partnership cannot participate in partnership activities. For example, under Minnesota state law (many states have similar laws), they can’t make investment decisions, decide when to make distributions, force the partnership to buy their interest, or dissolve the partnership, states Hause. Because of these restrictions, discounts for minority interest and lack of marketability are generally applied to the minority interest. It is this ability to take discounts that allows larger gifts of wealth and estate planning to reduce gift and estate taxes.

Assume two parents jointly own $1 million in real estate, stocks, bonds, etc. They create a Limited Family Partnership and receive all of the general interest and limited partner interest. Each parent owns 50 percent. If they each gave away 1 percent of the assets, that would be $10,000 each. If, however, they gave away limited partnership interest, say 1 percent, with the value discounted by 50 percent, each of the parents could distribute $20,000. There are no additional gift taxes when the child sells the assets, even at the higher actual value, because they don’t look back for gift taxes.

The parents are able to give more assets away each year, shifting wealth out of the estate. This is particularly important when the estate is too large to effectively be reduced through traditional gifts of the assets. Consider the aunt with a $3 million estate. She is entitled to an estate tax credit of $600,000, which she gifts in equal amounts to three nieces. The aunt and nieces put all $3 million into a Limited Family Partnership. The aunt owns $2.4 million and the nieces own the rest. The nieces are the general partners. When the aunt dies, all that is in her estate is the $2.4 million less the discounts. For illustrative purposes, assume a 50% discount. The aunt’s estate is valued at $1.2 million. Now the nieces pay estate taxes on $1.2 million instead of $2.4 million.

If there had been no Limited Family Partnership, Hause notes, the estate would have enjoyed a step-up in basis to the full amount at the time of the aunt’s death without capital gains. In the Limited Family Partnership, only $1.2 million is included in her estate, so only that amount is stepped up. Capital gains tax would have to be paid on the difference between the discounted basis and the actual face value of $1.2 million. However, in this particular example, that is preferable because the capital gains tax caps at 28 percent ($336,000) compared to estate taxes approaching 45% ($540,000).

THE INTERNAL REVENUE SERVICE IS WATCHING

Of course, these discounts are closely watched by the Internal Revenue Service. Congress recently passed new tax laws allowing the IRS to ignore certain paper discounts for gift tax and estate tax purposes, if the family controls the limited partnership and could dissolve the partnership immediately after the transfer of assets. However, many states have laws which protect discounts being applied by Family Limited Partnerships, and these laws cannot be overlooked by the IRS. The point? A Family Limited Partnership is able to take a discount if properly defined under state law, but the question from an IRS audit remains “how much is too much?” Typically, discounts in the 30-45% range are taken. If your goal is to get a 60% discount or more, you have more exposure, but in many cases there is ample justification.

FAMILY BUSINESS SUCCESSION FACILITATED

Assets included in the Family Limited Partnership can also direct family succession of a privately owned business. In this example, an owner wants to expand the manufacturing plant of the business. Even if the business owner retains all of the control at first, the owner can pass the business on to a child involved with the business and equalize values for other uninvolved children through gifts of interests in the Family Limited Partnership.

ASSET PROTECTION

Assume a business owner has personally guaranteed loans for the business. By putting stocks and individual liquid assets into a Limited Family Partnership with the spouse as general partner and the business owner as limited partner, the assets are protected. If the bank calls in the personal guaranty, it receives the business owner’s limited interest. As a limited partner, the bank is taxed on income associated with the limited partnership even though there may not be any cash distribution. The bank can’t force distribution and can’t liquidate the assets. The bank will soon want to negotiate out of the limited partnership.

IS A FAMILY LIMITED PARTNERSHIP RIGHT FOR YOU?

If your estate is over $1 million and you would like to minimize taxes through estate planning, a Limited Family Partnership might be the best tool for you. Hause suggests seeing your attorney for a complete analysis of your personal situation.

Attorney Larry Hause specializes in estate planning at the Minneapolis, Minn law firm of Fredrikson & Byron. For more information, call (612) 347-7000. (ARA)

Courtesy of Article Resource Association, www.aracopy.com, email: info@aracopy.com