The IRS has declared war on family limited partnerships (FLPs). It is in the middle of an aggressive audit program testing the validity of such partnerships for estate and gift tax (transfer tax) purposes.
In revenue ruling 93-12, the IRS agreed with earlier court decisions that allowed minority and marketability discounts for transfers of FLP interests.
Since publishing that FLP-friendly ruling, however, the IRS has issued several other rulings that deny discounts for transfers of limited partnership interests (PLRs 9719006, 9723009, 9725002, 9725018, 9730004, 9735003, 9735043 and 9736004).
Much of the IRS's current position is based on IRC sections 2703 (enacted to address the effect of buy/sell agreements and options on the value of closely held business interests) and 2704, "Treatment of Certain Lapsing Rights and Restrictions." These sections are both part of chapter 14 of the tax code and were included in legislation enacted by Congress in 1990.
If challenges based on sections 2703 and 2704 fail, the IRS may assert that the formation of the partnership itself and the transfer of partnership interests rather than the underlying assets are merely a device to transfer wealth to the transferor's heirs at a discounted value.
Accordingly, taxpayers must make sure that the facts surrounding their use of the limited partnership structure do not warrant IRS challenge. Taxpayers must enter into the partnership for valid business or investment purposes and document such purposes.
Wherever possible, the following conditions should be met in establishing limited partnerships:
- No partner is given a unilateral right to liquidate the partnership.
- Partnership agreements are drafted using state laws where section 2704(b) is moot.
- Rights and powers of assignees are no greater than those provided under state law.
- There is more than one general partner.
- The transfer of a partnership interest gives the recipient only the rights of an assignee under state law.
If these principles are followed and the partnership interests are not transient, the IRS should not have valid grounds to challenge the discounts found when valuing partnership interests in either a gift or estate tax context.
For more on this subject, see "Refuting IRS Challenges to the Use of FLPs," Jan.99, The Tax Adviser, page 28. The article was based on a position paper—by George L. Strobel II of the AICPA trust, estate and gift tax committee—the full text of which can be found on the AICPA Web site at www.aicpa.org/members/div/tax/flapap.htm.