I. PURPOSE OF A FAMILY LIMITED PARTNERSHIP OR FAMILY LIMITED LIABILITY COMPANY.

The family limited partnership (“FLP”) or family limited liability company (“FLLC”) may be utilized to accomplish multiple estate planning goals, including a gifting program involving gifts of partnership or LLC interests to descendants (or to separate trusts for their benefit).

As a general matter, the FLP or FLLC may be used to provide centralized management of family investments and to facilitate the transfer of assets from older generations to younger generations. Moreover, the entity may provide liability protection for a client and the client’s family. By transferring assets to an FLP or FLLC and administering it properly, it may be possible to retain some control of the family assets and at the same time give beneficial interests in these assets to family members (or to trusts for their benefit) by making gifts of partnership or LLC interests.

II. BENEFITS OF A FAMILY LIMITED PARTNERSHIP OR FAMILY LIMITED LIABILITY COMPANY.

The primary gift and estate tax benefit utilizing an FLP or FLLC is that interests in an FLP or FLLC may be transferred to future generations at a depressed value for tax purposes. Appropriate valuation discounts on the asset’s value (due to the limited marketability of the interests and the restrictions on their transferability) effect a tax-free transfer to the next generation. These discounts on the asset’s value effectively constitute a tax-free transfer to the next generation. For example, if an LLC membership interest valued at $3,000,000 is given as a gift, and a 30% valuation discount is properly available, then gift tax is calculated as if the LLC interest is only worth $2,100,000. Thus, $900,000 of underlying value may escape transfer tax, along with the future appreciation on the $3,000,000 asset. However, it is important to note that the IRS will not respect FLPs and FLLC unless their use also has non-tax motives and benefits.

The percentage discount applicable to the transfer of a family entity will vary depending on the restrictions in the FLP’s partnership agreement (or in the FLLC’s operating agreement) and depending on the nature of the underlying assets. Discounts in the 20% to 50% range have been sustained by the IRS, depending on the particular situation involved (i.e., the interest’s lack of marketability or the degree of control retained by the transferor).

III. RISKS OF A FAMILY LIMITED PARTNERSHIP OR FAMILY LIMITED LIABILITY COMPANY.

While there are many benefits to using an FLP or FLLC, this technique is not without risk. The IRS continues to challenge valuation discounts for transfers of interests in family entities consisting solely of readily marketable assets and/or real estate. In addition, the IRS challenges entities that lack a business purpose or entities that are administered without respect to their corporate structure. The IRS has attempted to invalidate FLPs and FLLCs by arguing that there is no true business purpose behind the entity, because such entities are created solely for tax-avoidance purposes. In addition, the IRS may attempt to invalidate the FLP or FLLC if the entity’s structure is not respected by the partners or members (e.g., because the creator treats the FLP or FLLC assets as if he or she personally owns them).

IV. CONCLUSION.

The use of an FLP or FLLC may increase a client’s level of tax risk, but it also provides several tax and non-tax benefits that should be considered.