Update on Flap over FliPs
Born after major "loophole closing legislation in 1990, family limited partnerships (FLPs, often pronounced "flips") became an estate planning rage in the early 1990s. By early 1997 almost 20% of the respondents to the Arthur Andersen/MassMutual American Family Business Survey '97 had an FLP. Undoubtedly, the percentage has increased since then as more and more advisors have jumped on the bandwagon. Not surprisingly, the IRS revved up its attack during the middle of the decade, concocting many novel arguments to deprive taxpayers of the increasingly touted benefits. (See March 1997 and February 1998 "Professional Insight" for details.) The IRS' interest was and continues to be the reduction or elimination of gift and estate tax valuation discounts due to the inherent lack of marketability and control in transferred limited partnership interests. What's the status of this popular technique? Well, the battle continues to rage. Taxpayers are winning on most, but not all, fronts. Occasionally, taxpayers are blowing off their own toes. The IRS continues pressure to put on the pressure, albeit with a growing sense of despair. And, fortunately, Congress is refusing to get into the fray, at least for the moment. The Courts Get Into the Fray Over the past several years, a substantial number of cases have been winding their way through the judicial system. The IRS typically selects taxpayers with the worst fact patterns for the "privilege" of litigation, and settles with the rest. Over the past year or so, several cases have been decided. The results have been predictable (the IRS might say "stunning") victories for the taxpayers. The courts rejected many of the IRS\' best arguments, most consisting of contorted efforts to apply obscure legal theories and elements of the 1990 legislation to deny the valuation discounts. But, there are more cases docketed, so the game continues. There have been a few instances in which the IRS has had some success in the courts. The first is the so-called "death-bed" partnership. You can count on drawing the IRS' ire by creating a partnership while on your deathbed. However, IRS did lose one case in which the partnership's senior generation owner died unexpectedly just two days after formation. Shot in the Foot The second fact pattern in which the IRS has had some success involves taxpayers failing to observe the formalities associated with the formation and operation of the partnership. In one case, the taxpayer purportedly transferred assets to a partnership that had not yet been legally formed -- fancy footwork similar to my dancing ability -- which caused problems for the taxpayer in court. Similarly, the taxpayer's failure to respect the existence of the entity (e.g., depositing partnership income in its checking account, failing to keep records, etc.) can cause the IRS and the courts to disrespect the partnership and the desired results. IRS Pressure Continues The IRS National Office continues its vendetta, castigating family partnerships in ruling after ruling. Like lemmings, IRS field agents continue to march to this official position that family partnerships are an affront to democracy as we know it. The examination division seems to have become better coordinated, with agents using relatively standardized materials with the same tired, judicially rejected arguments. However, the IRS appeals division continues to settle cases before litigation, typically permitting discounts in the 30% - 40% range without too much fuss. Congress Hides Head Treasury continues to ask for legislation to prohibit valuation discounts. However, with Congress in the mood to reduce or eliminate death taxes, nothing has occurred to change the legislative status quo. So, taxpayers generally are succeeding with both the tax and non-tax objectives inherent in the use of FLPs. Properly structured, they continue to provide a relatively certain means to discount gift and estate taxes by 30% - 40%. How long can this party last? There are two risks on the horizon. First, the Tax Court has been undergoing a quiet evolution. Members appointed in recent years seem to feel less than constrained by the wording of the law or by the precedents set in other cases. That is beginning to evidence itself in opinions that stretch to reach a conclusion that these judges think should be the law, rather than the conclusion that the law clearly provides. While these opinions likely will be reversed on appeal, this disturbing trend may adversely affect the FLP arena in the interim. Second, you can anticipate horse trading between the political parties in order to pass some form of estate tax legislation. The upcoming circus in Washington could result in the legislative disallowance of family partnership discounts, purportedly in exchange for increased transfer tax exemptions and reduced rates. The impact of such a trade-off undoubtedly would be detrimental to families with wealth in excess of a few million dollars. No surprise there.
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