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IRS Auditing Family Limited Partnerships

If you created a family limited partnership (FLP) in connection with your estate planning, this alert is for you.

The IRS is auditing virtually every U.S. estate tax return where one of the assets was an interest in a FLP and a discount was claimed on the value of that interest. The IRS has obtained varying results in its efforts as reported in court cases from around the country. The cases have been very fact specific, and FLPs have usually withstood the IRS assault, unless one or more of the following applies:
  • The formalities were not followed in the creation and administration of the entity.
  • The general partners, typically the parents, treated the partnership as their personal bank account and proper books, records and tax returns.
  • The general partners transferred all or substantially all of their investment assets to the partnership and did not maintain sufficient assets outside the FLP to support themselves.
  • The partnership was funded solely with marketable securities.
  • The partnership was set up near the end of the parent's life or by an agent acting on behalf of the parent.
  • Distributions to the general and limited partners were not made in accordance with their respective percentage interests.

If you are a general partner and your FLP activities can be described by any of the above criteria, we recommend that, in addition to taking appropriate action to correct such deficiencies, you consider doing the following:

  • Cease to be a general partner by exchanging your general-partnership interest for a limited-partnership interest with one of the limited partners becoming the general partner.
  • Gift any remaining partnership interests held by you to your children or grandchildren and file gift tax returns, if appropriate.

For many years the courts consistently supported FLPs and the significant discounts for gift and estate tax purposes. However, this caused heavy losses of revenue to the U.S. Treasury, which resulted in greater IRS scrutiny. Now that the rules are better defined, you should take care to follow them.

Questions?

If you have questions regarding this alert, please contact one of the following Gust Rosenfeld attorneys:

Michael H. Bate - 602-257-7406 - mhbate@gustlaw.com
Richard H. Whitney - 602-257-7424 - rwhitney@gustlaw.com

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