When is a family limited partnership an appropriate tax savings vehicle?

• Author: Washelesky, Frank L.

Family limited partnerships (FLPs) have become extremely popular estate planning tools, offering creditor protection, flexibility of structure and the possibility of limiting the rights of a younger generation. In addition, a properly structured FLP should also provide the taxpayer with transfer tax savings, through discounts on the value of lifetime gifts of limited partnership interests and potential discounts on the value of limited partnership interests held at death.

Discounts on Limited Partnership Interests Held at Death

If a taxpayer dies holding a limited partnership interest, discounts for lack of control and lack of marketability may be available; these discounts reflect restrictions on the limited partner's withdrawal and other rights. In order to claim the discounts, the taxpayer cannot have the ability to override these restrictions in his capacity as a general partner or manager of the partnership.

In Letter Ruling (TAM) 9719006, the Service recently attacked a taxpayer's right to these discounts on two fronts. First, the IRS argued that the formation of the FLP and transfer of the partnership units had no economic substance and should be ignored for estate tax purposes. The second argument relied on Sec. 2703(a)(2), which provides that, for transfer tax purposes, the value of property shall be determined without regard to any "restriction on the right to sell or use such property." The Service argued that the terms of the FLP restricted the rights to use and sell the underlying property; therefore, the FLP should be ignored for transfer tax purposes. The facts in the TAM were so objectionable that the IRS's conclusions seemed fair. However, most situations will not be so clearly objectionable; the Service may likely find courts reluctant to follow this same rationale.

Given the IRS's objections, it is clear that discounts on limited partnership interests and similar transactions will come under heavy scrutiny. Therefore, it is increasingly important, whenever possible, to document an FLP's business purpose and avoid the deathbed planning that resulted in the issuance of the TAM.

Discounts on Limited Partnership Interests Transferred During Life

The ability to transfer limited partnership interests in an FLP during a parent's lifetime, while claiming a discount on the value for lack of control and lack of marketability, can result in significant transfer tax savings.

Example: Parents M and F establish a valid FLP, which has...