It is almost the start of new year, and, as I am writing this article in December 2012, the uncertainty of the “Fiscal Cliff” is far from settled. One thing is for certain: your family wealth should continue to be addressed to ensure that it is preserved from both creditors and death taxes.
The “devil is in the details” is one of the most critical aspects in any business and tax planning strategy. In an audit with the Internal Revenue Service (“IRS”) for estate tax purposes dealing with a family limited partnership (“FLPs”), the outcome was very favorable for my client. My client received a 35% discount on the FLP’s assets because he paid attention the details in maintaining the FLP properly given the victories that the IRS has had in this area.
I have been called by a number of people asking whether or not FLPs” or LLCs are still valid, based upon recent the IRS victories in the tax court and stressed in its most recent audit settlement policies. These calls stem from the IRS’s successful use of IRC Code Section 2036 and the “retained interest” by the taxpayer.
A retained interest is an interest that was supposed to be transferred by an individual, but more often than not had some string attached (usually money back to them for personal living expenses) that cause the interest to be included in their estate. However, sale of an interest is acceptable to the IRS, if it is bona FIDE and for valid consideration.
The starting point to remember when creating either an FLP or LLC is to have a valid business reason to establish it in the first place. For example, a family residence or IRA will not be the type of assets that you would typically use for business purposes. Also, someone in their late 80’s or early 90’s, starting a business at that point in their life, will generally fail the “smell test”.
Paul Hood of Leimberg Information Services wrote an article for planners a couple of years ago that illustrates what needs to be done. Although he discussed 10 items, the two I want to stress are discussed below.
1. FISCAL FITNESS: Make sure the FLP/LLC is the right fit in your situation! Most mistakes that are made in the FLP/LLC arena are due to the inappropriate evaluation of the suitability of that entity technique in a particular situation. Simply put, many FLP’s/LLC’s fail due to improper “fit.”
Is your client too old or unhealthy for the FLP/LLC?
Will your clients follow the rules for FLP’s/LLC’s? Do your clients understand the importance of following the rules?