By Ken Berry, J.D.
How can a business owner transfer shares in the business to the younger generation without giving up control over day-to-day decision-making? A family limited partnership (FLP) may do the trick and save estate tax to boot. However, as shown in a new case, Estate of Fields, TC Memo 2024-90, 9/26/24, there must be a legitimate transfer of business ownership. This can’t be merely a means to reduce or avoid tax liability.
Basic premise: Typically, a FLP is formed by a business owner late in life. They can transfer shares in the business to the FLP and still manage daily activities as the general partner. Other family members, including children and grandchildren, may be named as limited partners Frequently, the owner may gift shares to the limited partners that are sheltered from gift tax by the annual gift tax exclusion.
As a result, the owner reduces the size of their taxable estate. Icing on the cake: The value of the shares may be discounted due to lack of marketability. This discount may be high as 30% or even more.
The family in the new Tax Court put a different spin on the FLP technique. It arranged for an ailing business owner to receive shares as a limited partners with a significantly discounted estate tax value.
Facts of the new case: The taxpayer owned a profitable oil business in Texas that she inherited from her deceased husband. She had extremely close ties to great-nephew.
While she was in declining health due to Alzheimer’s Disease, the taxpayer transferred approximately $17 million of her business assets to a limited partnership, using a durable power of attorney held by her great-nephew. In exchange, the taxpayer received a 99.99% limited partner interest with a discounted value of $10.8 million.
Despite the transfer, the FLP assets used to pay for the taxpayer’s normal living expense. Upon her death later the same month, the taxpayer’s estate reported the discounted value on its estate tax return, resulting in a significant reduction in estate tax liability.
But the IRS stepped in and objected. It said that the full $17 million value of the transferred assets should be included in the gross estate because the taxpayer retained full control over the property. To arrive at its determination, the Tax Court noted several key takeaways.
- The taxpayer passed away within a month of the FLP’s formation
- Little cash was held outside of the FLP to allow for normal living expenses. The FLP account was used like a personal checkbook.
- The estate tax was paid by FLP assets.
- Significant discounts for lack of control and marketability were applied to the taxpayer’s majority interest.
- The taxpayer wasn’t involved in the estate planning. Her great-nephew acted as the general manager and signed on her behalf as a limited partner.
Accordingly, the Tax Court concluded that the taxpayer had continued to receive income and benefits from the transferred property. In addition, the transfer of assets to the FLP was primarily motivated by tax avoidance. This was not a legitimate arrangement and thus the full value is subject to estate tax plus penalties.
Caution: The IRS often pays close attention to transactions involving FLPs. Make sure that such an arrangement is legitimate.
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Tags: Taxes
