Chapter 16 - § 16.7 • AVOIDING A SUCCESSFUL IRS CHALLENGE

• Jurisdiction: Colorado

§ 16.7 • AVOIDING A SUCCESSFUL IRS CHALLENGE

If the parties are careful to follow the above-summarized guidance, a limited partnership or an LLC can be structured to achieve valuation discounts for estate and gift tax purposes. In sum, when transferring business interests to family, there are a number of considerations that should be discussed between the attorney and his or her client.

First, an argument that the assets of an LP or LLC should be included in the decedent's estate because the decedent retained the right to the beneficial enjoyment of the entity's income must be avoided. To do so, advisors should observe as many of the following cautions as possible (understanding, of course, that it is unlikely that any client will be able, or even desire, to observe all of them):⁷⁸

• Avoid leaving unfettered control in the client;
• Do not transfer all or substantially all of the client's estate to the entity;
• Do not transfer the client's primary residence or other personal asset to the entity;
• Keep enough liquid assets outside the entity for the client's usual living expenses;
• Ensure that the entity complies with state law;
• Set up, maintain, and use proper bank accounts for the entity;
• Keep a minute book for the entity;
• Make periodic proportionate distributions from the entity to its owners;
• Name unrelated persons as partners/members of the entity;
• Obtain entity stationery and business cards; and
• Create an owner's manual that sets forth responsibilities.

The first six cautions listed would appear to be the most important in light of the discussion in the IRS settlement guidelines.⁷⁹

Second, the argument that the assets of an LP or LLC should be included in the decedent's estate because the decedent possessed, either alone or in conjunction with others, the power to control distributions from the entity or liquidation of the entity must be avoided. One way is to give the decedent only non-voting interests in the entity or in the general partner of an LP. Alternatively, the manager or managing partner should be subject to fiduciary standards. Also, the entity should have owners, other than the decedent, who own more than merely de minimis interests. These interests can be owned by family members or trusts for the benefit of family members (with the trusts having independent trustees),⁸⁰ but the owners must be treated as owners. Structuring an LP or LLC in this way also will be helpful if...