Submitted by: Albe Rtaa

During the last decade, family limited partnerships (FLPs) have come under fire from the IRS. That doesnt mean an FLP has lost any of its muscle as an estate and succession planning tool. What it does mean is that the IRS may attempt to shoot down an FLP it believes is nothing more than a tax avoidance scheme.

Fortunately, with careful planning, you can create an FLP thats bulletproofor at least bullet resistant. There are no guarantees when it comes to tax law, but designing and operating an FLP as a legitimate business rather than merely a tax-saving vehicle can help deflect an IRS challenge. A High-Caliber Planning Tool FLPs offer several benefits, including the ability to:

Consolidate ownership and management of securities, real estate or other investments

Transfer large amounts of wealth to children or other family members while retaining some control

Keep a business or other assets in the family

Ensure a smooth transition of business ownership from one generation to the next

Provide a mechanism for resolving disputes over the disposition of assets

Shield assets against personal creditors claims, and

Reduce gift and estate taxes through valuation discounts available to the limited partnerships interests (typically between 30% and 40%).

The key to preserving an FLPs tax benefits is to ensure that all partnerships are designed and operated to meet one or more nontax objectives.

FLP Red Flags

If youve followed recent court cases involving FLPs, you might think that the string of IRS victories signals the death of the FLP as a viable planning strategy. But most of these cases involved taxpayers who failed to follow the partnerships formalities and were unable to demonstrate a legitimate, nontax purpose for forming the FLP. Fortunately, the courts opinions provide a roadmap for helping you structure and operate an FLP that will likely survive an IRS challenge. The IRS looks at all the facts and circumstances in determining whether an FLP is legitimate. Consider taking the following steps to avoid any red flags:

Establish the FLP when partners are in good health.

Have all family members contribute at least some assets in exchange for their partnerships interest when the FLP is formed.

Partnerships interests received in exchange for contributed property must be proportional to the value of the property contributed to the FLP. This rule applies not only when the FLP is formed, but any time property is contributed to any partnerships

Partners should not contribute all of their assets to partnerships, but should hold back assets sufficient to maintain themselves if the partnerships were to cease making distributions.

Personal assets (e.g., residences, vacation homes, cars, etc.) should never be assets of the FLP.

Aside from personal assets, any asset can be used in the establishment of a FLP, but active business assets (e.g., actively managed real estate, oil and gas working interests, other business interests) are better than just securities.

Transfers of the partnerships interests from the older generation to the younger generation may be made by gift and/ or by sale. There are advantages and disadvantages to both methods, but either way, it is essential to have a contemporaneous, expert appraisal of both the FLP’s assets as well as the FLP interest to be transferred.

Make sure all partners are fully informed about the benefits and burdens of the FLP.

Observe formalities:

Change title to assets

Document all transfers of FLP interests

Maintain separate bank and investment accounts

Deposit FLP income to the FLP’s account

Pay FLP expenses (and only FLP expenses) from the FLP’s account

All distributions must be pro rata to the partners

If the FLP makes a loan to a partner, it must be interest bearing and secured. Try to transfer management and control to the younger generation as soon as it is feasible, and in the meantime, exercise control with an eye on your fiduciary duty to your partners.

Partnerships are to be treated as distinct and independent entities, separate from any of the individual partners.

Protect Yourself

An FLP remains one of the most powerful estate planning tools available, but you must exercise caution. Be sure to have a qualified tax professional and attorney to oversee every step of the process.

For more information about the services that RBZ can provide, visit www.rbz.com.

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