Preferential aspects of FLPs.

• Author: Wallgren, Don
• Position: Tax treatment of family limited partnerships

Chapter 14 of the Code was enacted in the Revenue Reconciliation Act of 1990 to curb perceived estate freeze abuses. However, the recent decline in interest rates and a number of developments have reinforced an effective method to retain a right to a fixed amount of income and control of assets while freezing their value for estate tax purposes--namely, a family limited partnership (FLP) with a retained preferential interest. The concept is simple: The parents transfer real estate, securities and other appreciating assets to a limited partnership in exchange for a general partner interest, a preferential limited partner interest and a nonpreferential limited partner interest.

The preferential limited partners might be entitled to a preference, such as a guaranteed payment for the use of capital as described in Sec. 707(c). However, care must be taken not to retain a preferential limited partnership interest that would be considered an applicable retained interest (such as a distribution right under Sec. 2701(b)(1)). In that event, a gift of a nonpreferential limited partnership interest would be subject to the special valuation rules of Sec. 2701 and would defeat the client's estate planning goals. Under Sec. 2701(c)(1)(B), however, a distribution right expressly does not include a right to receive a guaranteed payment (described in Sec. 707(c)) of a fixed amount.

By structuring the partnership with preferential and nonpreferential...