Each year end, we remind our clients about year-end gifting of Family Limited Partnerships and Limited Liability Company (LLC) interests in order to achieve tax minimization. This year, however, the need for leveraged gifting is even more crucial, because soon the U.S. Treasury Department will release proposed regulations that will eliminate the ability to discount the value of interests in private entities, including family corporations, FLPs and LLCs, to family members for gifting.
For estate planning purposes, the IRS currently allows a person to gift minority interest in one’s family owned business (FLPs and LLCs) to one’s heir(s) at a discounted rate. The IRS permits the discounted rate because these interests are not marketable, i.e., they are not attractive to anyone outside the family and therefore they are worth less than their fair market value. In addition, these interests are usually minority or non-voting interests, which is a second reason for a discount in value.
The tax code is ambiguous as to the discount rate acceptable for certain assets. Some taxpayers (including some of our clients) have taken up to a 50% discount on gifts of FLP interests. This ambiguity in the tax code has led to disputes between the IRS and taxpayers, some of which have been adjudicated before the U.S. Tax Court. The tax code allows the IRS to add restrictions to laws. The proposed regulations will eliminate any ambiguity by adding restrictions on discounts for closely held interests. Tax professionals have speculated that the proposed regulations may extinguish such discounting altogether.
Details about the proposed regulations are limited and speculative, but the proposed regulations could become effective retroactively. In light of the uncertainty surrounding the proposed regulations, it is imperative that individuals accelerate their estate planning by the end of the year to take advantage of current tax savings.
Clients with FLPs should consider gifting limited partnership interests, in order to decrease the value of their estate. As long as clients retain their General Partner (GP) interests, clients will continue to control all assets within their partnership. Yes, you can escape the estate tax and still control the assets.
Clients should also keep in mind that on the state level, the exclusions from state estate taxes can be much lower. In New York, the current estate tax exemption is $3,125,000.00 and rises to $4,187,500.00 on April 1, 2016. New York estates valued at 105% (or greater) of the exemption lose the exemption entirely. New Jersey imposes an inheritance tax on estates over $675,000. In Connecticut, the exemption is now $2 million and the estate tax ranges from 7% to 12%, depending on the amount above the Connecticut estate tax exemption. (Connecticut, along with Minnesota, are the only two states in America which also impose a gift tax.)
- You can lower the value of your taxable estate, and pass $5,430,000 ($10,860,000 for a married couple) to your heirs, tax free.
- If you own an FLP, you can gift Limited Partnership (LP) interests to your heirs, and take advantage of discounting, to get even more out of your estate, tax-free (up to $21,720,000 in 2015).
- You can keep your General Partner (GP) interests and still control the FLP and its assets, even if you gift all of the Limited Partnership (LP) interests.
Also, don’t forget about the annual gift exclusion, which allows you to gift up to $14,000 ($28,000 for a married couple) in 2015 to as many people as you choose.
We realize that gifting and discounting are not simple concepts, and we welcome your questions. We can advise you as to appropriate FLP discounts, prepare memoranda of gift for you, as well as the partnership valuation and gift valuation calculation letters (necessary for the IRS). Please contact us with any questions regarding your year-end tax planning.