The Internal Revenue Service does not like Family Limited Partnerships (FLPs), it is really that simple. The Internal Revenue Service has put “us” on notice that FLPs will be very carefully reviewed and challenged whenever the opportunity arises. The Internal Revenue Service views the FLP as merely a strategy to reduce the assigned value of an asset for Estate and Gift tax purposes without really reducing the true value of the asset. It is for the same reason that some clients want the creation of an FLP.
The FLP is a limited partnership that consists of more than one member; usually the FLP consists of a general partner that runs the entity and one or more limited partners that are passive in the operation. The tax benefit associated with the FLP is the result of a valuation discount that becomes available on transfers of fractional or minority interests in the FLP. The discount is, or should be, what the value of the asset has become to the reasonable prudent man for this fractional or minority interest in the partnership. The transfer of a limited partnership interest to an FLP by the general partner is considered a conveyance of an interest that is without marketability and therefore is discounted to reflect the “new value”. The discount in value can be as low as 25 percent and as high as 60 percent resulting in the reduction in taxation when taxing the “new “discounted asset. This is where the Internal Revenue Service becomes interested: Is the discount appropriate as a percentage? Is the asset truly diminished in value due to its limited partnership status?
Also, whenever it is determined that the partnership lacks a legitimate business purpose and is nothing more than a disguised attempted transfer at a discount, the Internal Revenue Service has adopted the position successfully that the partnership status should be disallowed. This results in the assets being taxed at full market value.
It must be remembered that the FLP can be a beneficial; the use of an FLP can reduce the asset value for transfer tax purposes. Also, the FLP can be utilized to make gifts and maintain control over the asset; however, without a legitimate business purpose –such as providing asset protection for family members, which must be stated in detail in the partnership agreement the FLP will be scrutinized by the Internal Revenue Service.
Although complex, the FLP can be a powerful device utilized in the reduction of gift and estate taxation as well as effective in other areas of asset control ; however this being said, The Internal Revenue Service has put us on notice!!
