The Internal Revenue Service is about to toughen the rules on a type of investment vehicle that has been abused by some very wealthy families to avoid millions of dollars in taxes. The wealthy are allowed to use family limited partnerships, family limited liability companies and their variants to hold family businesses, real estate or other illiquid, hard-to-value investments. And they can discount the value of the assets because that is seen as the only way people outside the family would buy in, particularly since nonfamily members have no control over what the partnership does. But some partnerships have put marketable securities, even cash, into the entities and still claimed a discount even though the investments have a value that is easy to determine. Others have taken steep and unreasonable discounts on the value of the partnership shares solely on the basis that the entity itself is family-owned. A few have gone so far as to value the assets they hold at a steep discount for estate tax purposes only to turn around and liquidate the partnerships and distribute the cash as soon as the statute of limitations on estate tax audits has passed.
The New York Times recently reported more on this subject in “Navigating Tougher I.R.S. Rules for Family Partnerships.” It appears that there may be new regulations restricting what will be allowed with family partnerships. There’s no definitive information on the exact terms of those regulations, their effective date or whether or not the wealthy should scramble to make transfers now.
The White House estimated in 2012 that closing this loophole could net at least $18 billion in tax revenue over 10 years. Assets in family partnerships, like securities and cash, still have a value that does not support a discount of 30%. Some advisers argue that the partnership, not the individuals, controls when securities are bought and sold and distributions are made. However, tax experts expect that entities set up to hold businesses or assets that require consolidated management, like rental properties, will still see some discount.
If a family has significant real estate, typically they use discounts to transfer interest in the entity. If you’re already setting up a partnership or making gifts to one to accelerate what they were doing, get it in under the deadline. The IRS won’t make the date retroactive, so get going.
Talk to your estate planning attorney about how this change may affect your estate planning.
Reference: The New York Times (August 17, 2015) “Navigating Tougher I.R.S. Rules for Family Partnerships”