James F. McDonough
December 31, 2015
Could this be the end for current family limited partnership discounts?
Recent news out of Washington, D.C. suggests that the Administration, the Treasury and IRS intend to eliminate or substantially reduce the availability of discounts in the valuation of interests in Family Limited Partnerships (FLPs) and other closely held businesses.
Currently, the family limited partnership discounts result from a lack of marketability and lack of control of the interest being valued. FLPs, for this purposes of this discussion, include limited liability companies. The State of New Jersey as its own regulation restricting discounts in a family setting. My experience with closely held and family businesses suggests that there is no market for a minority interest in such an enterprise because of the human element.
The increase in the federal exemption, currently $5,430.000, has taken some pressure off estate tax planning; however, many advisors are becoming more concerned about the income tax burden associated with rising individual tax rates and capital gains rates. The thought is that the higher marginal income and capital gain tax rates will do more long-term harm to the financial health of a family.
Ideas to consider
If we cannot discount our way transferring assets free of estate and gift tax with the same flexibility as in the past, should we focus on stepping up basis? This is question that is trending at the moment although one should not give up entirely on what has been established.
One strategy that should be considered is the use of existing FLPs in accomplishing an indirect transfer of wealth. A reader may be familiar with defective grantor trusts where the income is taxed to the grantor although he or she does not receive the income. The concept is the same in that FLPs are used where the right circumstances exist.
A parent has a low basis property that has been depreciated substantially although it is more in the way of market value. Children have either cash or other assets. An FLP is established whereby allocations of book depreciation exceed tax depreciation because the parent has already taken tax depreciation. In order to balance the economics of the deal, the children must receive tax allocations to prevent the parent from shifting, of taxable income that parent would have recognized, to the children.
Advisors should consider the use of curative or remedial allocations to increase the income tax liability of the parent. This would result in an indirect benefit to the children by reducing their tax liability. These rules are not likely to disappear any time soon. I suggest that clients may not be maximizing the benefit of existing FLPs through this indirect means.