Gifts of family limited partnership interests.

The question below was submitted for the annual liaison meeting held Nov. 29, 1995, between IRS Western Region representatives (including California district directors) and the California CPA Society's Committee on Taxation. This question and the Service's response were published in the committee's February 1996 bulletin, which was distributed to all society members. (Additional copies were provided for some IRS personnel at their request.)

Question: Regs. Sec. 1.701-2(d), containing the partnership anti-abuse rules, omitted former Examples 5 and 6, relating to family limited partnerships and gift tax issues that were in the previous version of these regulations.

Is the intent behind omitting these examples to remove situations described in those examples from the anti-abuse rules?

For instance, the formation of a family partnership whose sole asset consists of a vacation home was viewed under former Example 6 as lacking a business purpose. Accordingly, certain gift tax planning techniques involving the formation of a family partnership and subsequent gifts of discounted limited partnership interests to children were viewed as questionable under these previous regulations. Can we now assume that the IRS has acquiesced to this gift tax planning technique?

IRS response: The Internal Revenue Service has not acquiesced to this gift planning technique. When the Internal Revenue Service announced that Income Tax Regulation 1.701-2 would be amended to provide that it applies solely with respect to taxes under subtitle A (Income Taxes) and, accordingly, deleted Examples 5 and 6, it cautioned that "no inference is intended as to the treatment under current law of transactions not covered by the regulation." Announcement 95-8....

Neither the Western Region nor the Internal Revenue Service have specific guidelines regarding a family limited partnership as a legitimate (or abusive) gift tax planning technique. Of course, the facts and circumstances surrounding the creation of a limited family partnership and its activities can be scrutinized by the Service to determine whether abuse has occurred. If it appears that the entity was created primarily for purposes of reducing the value of the assets (placed in the partnership), the Service in the appropriate circumstances may determine that, for purposes of estate and gift tax, the partnership was abusive.

Observation

Family limited partnerships continue to be useful in accomplishing various tax and nontax objectives. However, as the Service's answer indicates, IRS scrutiny can be expected of "the facts and circumstances surrounding the creation of a limited family partnership and its activities...to determine whether abuse has occurred."