Dividing Up the Pie, 05-01-2008

Estate Planning is a complex area because it deals with so many different issues, from asset protection to taxation and almost everything in between. There are various different legal strategies and tools that have been regularly utilized to assist in reducing the value of the estate for tax purposes while keeping the assets in the family.

One of these strategies is the use of the Family Limited Partnership (“FLP”) or Family Limited Liability Company (“FLLC”). With this strategy, the parents title assets in the name of the FLP and then gift portions of the FLP to their children or other loved ones. It is like giving away pieces of a pie. Because each piece is valued individually, the sum of the parts do not necessarily equal the whole. This is because a buyer would not pay full price for a fractional percentage interest in the FLP, since profits are shared with the other partners and the buyer may not have control over how the FLP is managed or when the FLP would be dissolved or the assets sold. As a result, substantial valuation discounts may be obtained. In other words, not only are you giving away pieces of the pie, you are actually shrinking the size of the pie for estate or gift tax purposes. Some time after the parents’ deaths, the heirs, who are the FLP partners, can agree to dissolve the FLP and the assets almost magically return to their full underlying value.

This can also be a way of giving interests in property to beneficiaries who may not yet have the ability to manage assets wisely. It is more difficult for creditors to get at the assets when they are in the FLP than if they were held outright by the beneficiaries.

In the past, parents could keep control over the FLP by retaining the general partner interests and still could reduce their estate by giving away the limited partnership interests. But, a few years ago, the IRS cracked down on this strategy and successfully argued in several court cases that the parents cannot benefit from the income or assets associated with the FLP units that were given away or retain control over dissolution of the FLP or distributions from it. Then, the IRS unsuccessfully tried to disallow the strategy entirely. Several recent cases have upheld FLPs as a viable estate planning strategy, at least when they are properly structured and administered.

While FLPs and other advanced planning strategies may not be for everyone, they can be a good tool to minimize estate taxation and maximize asset protection. However, you should seek the advice of an experienced estate planning attorney at Morris Hall to determine whether an FLP is appropriate for you and for assistance in setting up and administering the FLP.