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Proposed IRS Regulations Go After the Family Limited Partnership

By Jonathan R. Tung, Esq. on August 24, 2016 | Last updated on March 21, 2019

If your client operates a business through a Family Limited Partnership, professional responsibility requires that you apprise them of possible changes on the horizon that could substantially affect these entities' tax exposure.

This is big news for high net-worth families who have successfully utilized the Minority Interest Discount to reduce estate taxes for the next generation. But how do you break the news to your rich clients?

In a Nutshell

The very wealthy have access to methods that allow a significant reduction in estate taxes to their children and descendants. These methods are legal but controversial -- in large part because these methods require money and give the perception that the rich are not paying "their fair share."

Morality aside, the techniques have been effective. One of the more favored methods involved the creation of a Family Limited Partnership, a business-quasi-estate planning tool that called for the transfer of significant assets to the entity, thus divesting the transferor of legal control of said assets. Not only does this lack of control make the assets harder to get at from the point of view of creditors, it also allows the transferor to claim a minority interest discount and a discount on theory of reduced marketability. What does this mean for purposes of estate tax reduction? Think between 30-50 percent.

The Party Is Coming to an End

Well, all good things must come to an end. The IRS, under Obama administration policy pressures, has increasingly come under the impression that well-heeled families are not forming a good number of FLP for legitimate "family business-related" purposes, and are instead doing so with tax-reduction (evasion) purposes in mind.

Under Section 2704(b)(4), the Treasury Department is given rather broad power to issue further regulations as they relate to valuation discounts mentioned above.

Well, someone along the way thinks that there's abuse in the system. On May 10, 2015, the writing started appearing on the wall. A speaker at the American Bar Association's Tax Section Meeting commented on a number of proposed regulations and crackdowns that the department had in the works, including a limiting of valuation discounts toward the latter end of 2015. It's 2016 now -- and although the wealthy have dodged bullets so far, a 90 day comment period will be coming through November with the new regulations set to take effect the year after this.

Tax Dodgers: Brace for Impact

A quick perusal of the internet seems to suggest that lawyers and other professionals in the area don't think that FLPs formed with legitimate business purposes have much to fear.

However, FLPs formed primarily not for the purposes of creating a business concern had better watch out. The IRS is going to take a very scrutinizing look at FLPs that have all the badges of being a tax-evasion tool.

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