Family Limited Partnerships: Are They Still Alive and Kicking?

About a year ago, a lawyer wrote an article about family limited partnerships in The Florida Bar Journal. Since then, the IRS has won two cases involving family limited partnerships. The article discusses these recent cases and provides tips on how to avoid making the same mistakes. It also talks about a survey that showed many family limited partnership cases have been settled in favor of the taxpayer. After Mrs. Disbrow’s husband died, she owned their home by herself. Her lawyer advised her to transfer the home to a family partnership in order to avoid estate taxes. Mrs. Disbrow did this and gave her share of the partnership to her kids. She continued to live in the home and pay rent to the partnership. When she died, the IRS said she still owned the home, and her estate had to pay taxes. Mrs. Disbrow transferred her house to a partnership but kept living there. She had lease agreements with the partnership that allowed her to use the house however she wanted. Even though she was supposed to pay rent, she often didn’t, and the partnership never did anything about it. Mrs. Disbrow also paid for things like taxes and insurance for the house. The court said that it seemed like Mrs. Disbrow still owned the house, even though it was technically in the partnership’s name. Mrs. Disbrow’s children and their spouses wanted her to continue living in the residence after it was transferred to Funny Hats. The court didn’t believe Funny Hats would have evicted her, since they were all family members. The court also found that Mrs. Disbrow did not pay the full rental value for the residence and there was no evidence that anyone else used the property. In another case, Mrs. Rosen’s children became trustees of her trust when she became ill, and her son-in-law, who was a lawyer, suggested creating a Family Limited Partnership to lower the value of her estate for tax purposes. Mrs. Rosen created a partnership with her children, where most of the money put in came from a trust set up by her daughter. Her daughter then gave away most of her share in the partnership to other family members, leaving only 35 percent for the trust. When Mrs. Rosen died, the partnership gave the trust that remaining 35 percent, but the IRS said that was not allowed. The court decided that Mrs. Rosen did not have a good reason other than avoiding taxes for setting up the partnership, so the IRS was right. The court found that the partnership formed by Mrs. Rosen and her children was not done properly. Mrs. Rosen, who was not in good health, did not really have a say in how the partnership was set up. Her children also didn’t contribute much to the partnership, and they moved a lot of Mrs. Rosen’s money into the partnership, leaving her with not enough to pay her bills. The LRFLP was not really a proper business. It didn’t keep the right financial records, follow the partnership agreement, or operate like a real partnership. Mrs. Rosen’s estate said there were good reasons for making the LRFLP, like centralizing management and protecting her from debt, but the court didn’t agree. They thought the real reason was to avoid paying taxes. The court found that Mrs. Rosen had retained control and benefit of the assets transferred to the partnership, so they still had to be included in her estate for tax purposes. This is similar to other cases where the IRS has been successful in challenging family limited partnerships. However, in reality, the IRS often settles these cases with favorable results for the taxpayer. A questionnaire sent to Florida lawyers with experience in estate tax matters showed that the IRS doesn’t always deny these cases and often settles them with taxpayers. Out of 350 e-mails, 41 people responded, which is a 12 percent response rate. 22 people completed IRS audit matters, and all of them were granted a discount on the valuation of their FLP interests. The discounts ranged from 10 percent to 55 percent, with an average discount of 30 percent. One-third of the respondents had real estate FLPs, and their average discount was also 30 percent. So, the IRS does grant discounts for FLP interests, and the discounts seem to be reasonable. Out of the FLPs (Family Limited Partnerships) that consisted of either stocks and bonds or real estate, the ones with stocks and bonds were more likely to have bigger discounts. This goes against what the IRS and courts are looking at, so it might not be accurate. The length of the partnership didn’t seem to affect the discount for real estate FLPs, but for stocks and bonds FLPs, the discounts varied. Only a few of the FLPs had an active business, and they all had real property and got discounts. In some cases, when people passed away and left property behind, their families formed partnerships to manage the property. These partnerships were not very active. In those cases, the property was valued at 10-30 percent less than its actual worth. About 22 percent of the time, there were some issues that made the property worth 18-39.5 percent less. In one case, there wasn’t even a partnership agreement. In another case, the partnership documents weren’t organized properly. In a third case, the person who owned the property was very sick and passed away soon after forming the partnership. In a fourth case, the sick person’s partnership loaned money to their estate. The IRS is giving big discounts on family investment partnerships, even when they don’t have a real business and are just made up of stocks and bonds. This means families can lower their taxes by a lot when they pass on their money to their kids. But the rules might change, so it’s not guaranteed to work in the future. To sum it up, if a Family Limited Partnership (FLP) has really bad facts, the IRS will probably win under a certain law. Planners should look at previous court cases to see what mistakes to avoid when setting up FLPs. However, if there are only a few bad facts and some good ones, the IRS might settle with discounts that are good for the taxpayer. We want lawyers to do their jobs well and help people. We also want to make sure the legal system is fair and always getting better.

Source: https://www.floridabar.org/the-florida-bar-journal/family-limited-partnerships-are-they-still-alive-and-kicking/