|
FAMILY LIMITED PARTNERSHIPS & DISCOUNTING
Family limited partnerships
(FLPs) reduce estate taxes by the combined operation of discounting the
value of limited partnership interests, and gifting the discounted limited
interests.
The two
principals work together:
-
First, the value of a limited
interest in the FLP is discounted.
-
Once discounted, more FLP
interests can be gifted tax-free to the next generation, which results in
more assets passing out of an individual s taxable estate.
It is important to remember
that control of partnership assets always remains with the general
partners, and is never given away.
The principal of discounting
recognizes two inherent reductions in the value of a limited interest in a
family limited partnership.
One discount recognizes that
a limited interest in an FLP is a non-controlling interest.
A second discount recognizes
that there is no ready market for the sale of FLP limited interests. The
courts have forced the IRS to recognize the validity of these two
discounts and such recognition has been codified by the IRS in Revenue
Ruling 93-12.
The IRS routinely accepts
discounts in values of limited interests in FLPs varying from thirty
percent to as high as fifty percent, depending, among other things, on the
liquidity of the FLP's assets, the likelihood of a distribution or
liquidation and the profitability of the FLP.
It is important to understand
that the discount applies to the value of the interest in the FLP; the
value of the asset held in the FLP remains the same.
Thus, for example, a family
home worth $1,000,000 before estate planning, remains valued at $1,000,000
after its contribution to an FLP.
If the home is sold, it would
command a sale price of $1,000,000 whether or not it is contained within
the FLP.
Consider the case of "Dr. and
Mrs. Jones," fictitious characters derived from actual client situations:
The Jones family home, valued
at $1,000,000, is contributed by Dr. and Mrs. Jones to the Jones Residence
Family Limited Partnership.
Although the value of the
home is preserved after its transfer to the FLP, the FLP can accomplish
significant estate tax savings via gifting of discounted limited interests
in the Jones Residence Family Limited Partnership.
[NOTE: Although, for
illustration purposes, we have created a hypothetical physician, the
principles discussed herein apply equally to all individuals who have
accumulated significant wealth.]
The IRS would recognize a 50%
discount in the value of a limited interest in an FLP containing
non-liquid assets such as real estate. Thus, although the FLP containing
the Jones family home is worth $1,000,000, the value of all the limited
interests of the FLP, discounted at a rate of 50% equals $500,000.
Assume that Dr. and Mrs.
Jones wished to gift as much as possible to their children during their
lifetimes in order to minimize the value of their estate at death. Using
$500,000 of their combined $2,000,000 unified credit,
Dr. Jones and his wife would
make a tax-free gift of $500,000 worth of limited partnership interests to
their three children. Because of the discounting, this gift would
effectively transfer all the limited interests in that FLP out of their
estate to their children.
[NOTE: The unified credit
(currently $1,000,000 per person) is not exclusively reserved for death;
it may instead be used to exempt a gift made during one's life from gift
taxes.]
In effect, by making a
$500,000 tax-free gift of discounted interests, Dr. and Mrs. Jones
transferred 98% of a $1,000,000 partnership.
Upon their deaths, Dr. and
Mrs. Jones, as 1% general partners, would each own $10,000 worth of
partnership interests (subject to negligible estate tax), but they would
have controlled the entire $1,000,000 FLP until the very end.
In addition, future
appreciation on the value of the limited partnership interests given to
the children will be excluded from Dr. and Mrs. Jones taxable estate.
In summary, Dr. and Mrs.
Jones goals of minimization of estate taxes and preservation of family
wealth for their heirs are efficiently and completely accomplished by the
use of FLPs.
Through the principle of
discounting, coupled with tax-free gifting of the discounted limited
partnership interests, the value of Dr. and Mrs. Jones taxable estate will
be reduced to zero, although they will retain complete control over their
assets, as general partners of the FLPs.
Through the implementation of
the FLP plan, the Jones children will be able to inherit all of their
parents' wealth, with nothing paid to the IRS.
|
