Family Limited Partnership

[Unregistered]

Is anyone familiar with Family Limited Partnerships?
My client setting up a FLP and transferring his "farm" to this FLP. The "farm" is really land he owns, he does not farm it.
Is there anything I should warn him about by doing this?
Your help is appreciated.
Noel

[Bees Knees]

FLPs

There are two issues that come to mind with respect to Family Limited Partnerships (FLPs).

1) They are used to transfer ownership of property to heirs while at the same time save on estate and gift taxes. This is done primarily by the use of minority discounts. If you own property, and give your kid a 5% interest in that property, the gift tax may be based on something less than the value of the 5% interest under the minority discount rules. For example, say I give you $100 worth of my property, but you can’t turn around and sell your interest, nor do you have any management control over the property because you are a minority owner. So although you could get $100 for your share of the property if I decide to sell today, the minority discount might make that share worth only $80 for gift tax purposes due to your lack of control over the property as a whole. In a family relationship then, the minority discount saves on gift tax when the interested is gifted to a family member, and then reduces estate tax when the majority owner (the parent) dies due to the fact that the parent no longer owns 100% of the value of the property at death.

2) The second issue has to due with transferring income from income producing property to family members in a lower tax bracket. Dad makes too much money. So he transfers a portion of the right to that income through an FLP to his son, who is in the lowest tax bracket.

The code has restrictions on these two types of planning. First, the FLP has to have economic substance. You can’t just transfer personal property into a Partnership and call that a business. There has to be some kind of trade or business, or investment purpose to the partnership. The farm land in your example would have to be considered investment property that is appreciating in value.

The code also has restrictions to the transfer of income through FLPs. IRC §704(e) deals with capital interests in partnerships. Basically, you can transfer the right to income to a family member in a lower tax bracket through an FLP if capital is a material income producing factor in the partnership. Your land appreciating in value would be considered capital as the material income producing factor in that FLP. But lets say the partnership is a service partnership, such as the business of farming. Income is produced through the labor of the farmer. In that case, the FLP produces income from the labor of the majority owner, so the income from such labor cannot be shifted to the minority owners.

These are just a few issues I can think of when it comes to FLPs. Maybe others have other ideas you need to think about.

[Unregistered]

Bees Knees

Thank you so much for taking the time to reply to my post. I appreciate your input.

Your answer raised a couple more questions.

1)Since my client is transferring the land in 2005, will I have to file a gift tax return in 2005 to reflect the gifting of the minority interests?

2) What if the FLP agreement allows the kids to sell their minority intrerest?

[Bees Knees]

The gift tax return is required for the year of the gift. So yes, you would file a gift tax return for 2005, the year the land is transferred into the FLP.

As to a minority interest having the right to sell their interest, I am not an expert, but I believe that is the whole argument behind being able to discount the value, due to the fact that minority interests do NOT have the right to sell or market their interest. I believe you would drastically reduce, if not eliminate the discount entirely if the minority interest had the right to sell their interest.

[JON]

FLP transfers

Usually the first transfer is the land into a partnership where the donor gets general and limited partnership units. Second you gift partnership units to whoever you want. Usually this will be done over years getting the gift exclusion each year. The reason FLPS exist is IRS lost and partnership units can be discounted for "minority interests"/"lack of marketability" and a few others.... The result is the partnership units can be gifted and control can stay with the general partner.

Even if the gift tax return is not required because discounts on the gifts get you below the gift exclusion-FILE the return. You are taking the discount you have to state that and attach the calculation on how it is arrived it. The chances of audit is almost 100%, but that is fine the size of the discounts and the business/investment intent will be questioned, but it is better to get solved now then years later in an estate.

Every year you gift you need valuation, but can be very much worth it. IRS and Clinton admin wanted these killed in the mid 90s. They are still here-attorneys seem to think there is now enough case law to establish them, at least until legilative action details otherwise.

Good luck

[Unregistered]

Thank You!

Thanks for you help.
Noel