FLPs and valuation discounts.

The family limited partnership (FLP) has quickly become a staple in the estate planner's "toolbox." Over the past several years, FLP formation to achieve estate tax savings has grown dramatically. The primary purpose for creating FLPs is to hold certain assets and use the partnership to transfer ownership in them by transferring limited partnership interests to other family members. The result is that ownership in family assets is transferred at a reduced gift-tax cost without inclusion in the donor's estate. There are other benefits to FLP use, including retaining control of certain family assets by senior family members and protecting certain family assets from creditors.

Gift and Estate Taxes

The IRS has consistently resisted FLP use as a vehicle to reduce gift and estate taxes. The typical scenario involves creating an FLP to which older family member(s) contribute assets in exchange for a general partner interest and a significant percentage of limited partnership interests. The younger generation contributes assets or cash for a smaller percentage of the limited partnership interests. The elder generation typically retains control over the assets through its general partner interest and proceeds to gift its limited partnership interests to the younger generation, using substantial valuation discounts for gifts of minority interests. The Service prevails in limiting valuation discounts when such discounts are overly aggressive or the partnership agreement places excessive restrictions on the limited partners or provides too much discretion to the general partner.

FSA 9919009

The IRs issued Field Service Advice (FSA) 9919009, in which FLP interests were not permitted a discount. In the FSA, the partnership agreement provided that the entity would continue for 50 years or until the general partner and more than 50% of the limited partner interests agreed to termination. No partners could withdraw or reduce their capital contributions until termination. The partnership agreement could be amended only on the same basis as termination. The FLP was created under Missouri law, which provided that a limited partner may withdraw from a limited partnership only at the time or on the happening of events specified in writing in the partnership agreement.

Restrictions

The provisions of the partnership agreement in FSA 9919009 were more restrictive than state law. Sec. 2704(b) addresses the effect of restrictions on transfers between family members. It states in part that certain restrictions are disregarded for valuation purposes to the extent they are more restrictive than state law. The Service concluded that the provisions preventing liquidation came within Sec. 2704(b)'s scope, and were, therefore, to be disregarded in valuing transferred interests to the extent they were more restrictive than state law limits.

New Proposals

The IRs has furthered its resistance to the use of certain FLPs. On Feb. 22, 1999, the Fiscal Year 2000 budget proposals were released. One of these proposals would eliminate nonbusiness valuation discounts. In the past, there has been a question as to whether valuation discounts were appropriate for FLPs with only marketable securities. Significant discounts for minority interest gifts to other family members are currently the standard. The proposal, however, would eliminate valuation discounts, and require minority interests to be valued at a proportional share of the FLP's net asset value, to the extent it holds nonbusiness assets. This proposal would also apply at death. If this proposal were enacted, it would significantly limit the discounts presently enjoyed through the use of FLPs.

FROM JOHN W. LINDBLOOM, CPA/PFS, HUBER, RING, HELM & Co., P.C., ST. Louis, MO

Philip E. Moore, CPA, MBA Brown, Dakes & Wannall, P.C. DFK International Fairfax, VA