Family limited partnerships: IRS rule changes could cost you a bundle

By Marc Lewyn   |   August 24, 2015

Usually when we hear “Act Now!” or “Limited Time Offer,” it’s time to be wary, grab our wallets and walk away. But this time, it could just be true:

The IRS is considering changing its rules on the taxation of family limited partnerships (FLPs) – perhaps as soon as September 2015. Those rule changes could cost you a bundle.

For years, wealthy taxpayers and their advisors have used FLPs as their “go to” technique for discounting the value of assets for estate tax purposes. So, is your current FLP or the one you’re contemplating creating in jeopardy? Perhaps.

Let’s review how an FLP works. Typically, a wealthy couple or business owner conveys a non-controlling interest in their family business or real estate interests to a family limited partnership. Partnership shares are then divvied up among family members. The FLP serves a number of vital purposes, but usually, the primary motivating factor is a desire to reduce estate taxes.

A family limited partnership can deliver a substantial reduction in estate taxes. Assets conveyed to an FLP currently are subject to a substantial discount for valuation purposes – from 20% to as much as 45-50%. That could represent an enormous estate tax reduction for you and your family.

The rationale behind this valuation discount has been that the assets aren’t worth as much on the open market. Why? Because no buyer would pay top dollar for a minority interest in a family business when it’s a non-liquid, non-controlling interest.

The IRS has now called that rationale into question, at least for some FLPs, meaning taxpayers soon could lose the opportunity to benefit from the FLP’s valuation discount.

Over the years, FLPs have been used to discount a wide variety of assets in a number of situations. Now the IRS is considering cracking down on what it sees as abuse of this age-old strategy.

Though we aren’t tax advisors and don’t own a crystal ball, we believe the IRS likely will soon distinguish between FLPs and their assets for valuation purposes, allowing the continued discounts in some, but not all circumstances:

  • FLPs that exist for what the IRS deems “a legitimate business purpose” – such as holding multiple real estate properties, other businesses that need centralized management and the like – would continue to be entitled to a discounted valuation on asset transfers; however,
  • FLPs that serve no legitimate business purpose and exist solely as a vehicle for transferring highly liquid assets (such as securities) at a discount could be at risk.

The IRS has reason to be concerned about curtailing abuse of FLPs and other intra-family transfers designed to obtain valuation discounts. The Senate budget committee estimates the loss of revenue to the U.S. Treasury through these discounted partnership valuations to be as much as $18 billion over 10 years.

The White House is watching. The valuation discount is just one of the tax “loopholes” being considered for closure through executive action. Given that Congressional action is unnecessary, time could be of the essence.

What should you do?

We side with the experts who recommend that families act now to create and fund a family limited partnership before the IRS changes the rules. While there’s no guarantee if or when the valuation rules might change − or exactly what those new rules might be − we believe it’s prudent to take advantage of these favorable tax rules while you still can.

Moreover, we believe it’s highly unlikely that the IRS would change the rules to limit the discounts on existing partnerships. Rules are rarely applied retroactively, so it’s critical to get your FLP up and running under the wire.

If you’re interested in taking advantage of these valuation discounts (or if you’re already considering an FLP), let’s explore your options sooner rather than later. There are subtleties to consider when structuring, funding and operating these partnerships; we could provide ideas to help you:

  • Have more control over what happens to your business
  • Tie future generations together, and
  • Protect family assets from creditors.

For once, that old TV gimmick might be right – the current IRS valuation rules may really be a truly limited time offer.

Marc Lewyn

About the Author

Marc Lewyn is a partner, senior financial advisor, and CEO of Strategic Liquidity Services ("SLS") at JOYN. SLS provides a methodology designed to help business owners navigate the complex options available for generating liquidity from their businesses. Marc also hosts “Diversify Your Wealth Beyond Your Business,” a “Ted Talk” style workshop for Atlanta business owners. Learn more / RSVP here.

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