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FLP DISCOUNTS LIVE

May 07, 2008

Family limited partnerships (FLPs) became a popular way to reduce the taxable value of gifts and decedents estates in the 1990s. The tax law allows partners to value partnership interests at a discount from the underlying assets in the right circumstances; that's because sharing ownership of a property is more complex - and potentially more expensive -- than owning the property alone.

The IRS has overturned a number of FLPs in court. If you set up an FLP on your deathbed, or if you treat the partnership as your personal piggy bank after you have allegedly "gifted" interests in the partnership, the IRS is likely to have its way in court.

If you do things right, though, FLPs can still be a powerful estate planning tool. The Tax Court earlier this week allowed a Minnesotan to discount taxable gifts of real estate FLP interests by 33.9% for one year and 35.6% for another - saving the taxpayer somewhere around $2 million.

The Tax Court doesn't say much about the governance of the partnership, but it does say this:

Under provisions of the AFLP agreement, AFLP's net cashflow was to be distributed annually among the partners. The limited partners were not entitled to vote on matters relating to management of AFLP, no outside party could become a partner in AFLP without consent of petitioner as general partner, a limited partner could not sell or transfer any part of his or her AFLP limited partnership interest without consent of petitioner, and no real property interest held by AFLP could be partitioned without consent of petitioner.

So the general partner retained operating control of the entity, but it was supposed to distribute free cashflow. The IRS apparently didn't challenge the reality of the partnership, which leads one to assume that the partnership was operated like a business, rather than as a continuing piggybank for the donor.

The Moral? If you use an FLP for estate planning, you need to respect and abide by the agreement, run it like a business, operate it for other than tax-avoidance reasons, and you need to leave enough assets out of the partnership that you won't starve if you can't raid it.

Cite: Astleford, T.C. Memo 2008-128

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