Family limited partnerships survive and thrive: act while you can
In a recent decision, the normally unfriendly United States Tax Court ruled in favor of a taxpayer in a family limited partnership ("FLP") case.
In Estate of Shurtz (.pdf), the Tax Court ruled that despite somewhat lax observations of the corporate formalities, a FLP was nevertheless formed for legitimate non-tax reasons and that the formation was a bona fide sale for full and adequate consideration. The Tax Court held that asset protection and protection of the family business is a legitimate non-tax purpose.
While the Shurtz' FLP followed ordinary formation procedures, the FLP:
- failed to open a checking account for at least 4 months
- made disproportionate distributions
- did not keep normal partnership records (accountant's records served as the paper trail to document capital accounts and other transactions).
Nevertheless, the court ruled there was a bona fide sale for full and adequate consideration. Reviewing the factors set out in Bongard (.pdf), a 2005 Tax Court case, the Shurtz Court noted:
- The contributors received interests in the FLP proportionate to the ownership interest each contributed. The Shurtz engaged an accountant to calculate the value of a 1-percent general partnership interest in the FLP based on the value of the total property being contributed. The Shurtz each contributed property equal to the value of a 1-percent general partnership interest and the 98-percent limited partnership interest.
- The respective assets contributed were properly credited to each partner's respective capital account.
- Distributions from the FLP required a negative adjustment in the distributee partner's capital account.
- Asset protection and protection of a family business is a legitimate and significant non-tax business reason for the establishment of the FLP.
For these reasons, the Tax Court was satisfied that the formation of the FLP and the contribution of property to the FLP were carried out in the way that ordinary parties to a business transaction would do business with each other. Consequently, the Tax Court ruled that the transfer of property to the FLP was made for adequate and full consideration.
FLPs, which include family limited liability companies, present a great opportunity to pass family wealth to future generations at discounted values, while at the same time providing significant asset protection features to preserve and protect a family's accumulated wealth. However, the window of opportunity for passing wealth at discounted values may be closing soon.
The most recent proposal sent over by the White House substantially restricts valuation discounts. If the legislation is passed in its current form, any entities formed and funded after the effective date of the legislation will lose valuable opportunities for discounting. Once closed, the window may remain closed forever.
