Discounts on family limited partnership – Challenged when preparing a valuation

Thought Leadership presented by Grassi & Co

The current regulations, Revenue-Ruling 93-12, allow for discounts when valuing a Family Limited Partnership (FLP).  The proposal is expected to potentially limit the allowed discount and consequently raise the taxable portion of the trust or estate structures.

What is a Family Limited Partnership?

A FLP is a type of partnership designed to centralize family business.  FLPs pool together a family’s assets into one single family-owned business partnership that family members own shares of.  FLPs are frequently used as an estate tax minimization strategy, as shares in the FLP can be transferred between generations, at lower taxation rates than would be applied to the partnership’s holdings.  A FLP is different from a conventional trust, as family members actually own a share in a business.  Shares can be gifted to family members over years, thus taking advantage of gift tax exemptions on an annual basis.  The assets held in an FLP impact the level of estate tax savings that can be realized by using an FLP.  In general, the more illiquid and complex the asset mix, the more difficult the FLP is to evaluate, and the larger the potential for estate tax savings.

Today, the FLP structure is a highly debated and a heavily scrutinized tax area in estate and trust planning.  FLP’s are viewed by many as one of the most significant and efficient estate and gift tax planning strategies.  This strategy includes freezing or stabilizing the value of what’s owned by a family and transferring the assets at a reduced value, thereby minimizing the taxable portion of the estate or trust in which the assets were placed.  This offers the potential for substantial tax savings when shifting wealth to younger generations.  A popular method of freezing value is to form an entity in which the older members of a family would acquire and hold the preferred interests; this is a value which tends to be stabilized.  Simultaneously, the younger generation would acquire the common interests, which were expected to grow in value.  This is a common way to reduce the valuation of the entity holding the assets.

These are the attributes often found in a FLP:

  • FLP’s are frequently used to move wealth from one generation to another;
  • FLPs are typically holding companies, acting as an entity that holds the property (business interests, real estate investments, publicly traded or privately held securities) contributed by the members;
  • FLPs have several benefits: they allow family members with aligned interests to pool resources, thus lowering legal, accounting, and investing costs;
  • FLPs also allow for favorable tax treatment relating to the transfer of the assets; the benefits of the discounts for the lack of control (DLOC), and lack of marketability (DLOM) can translate to a lower tax liability.

However, because of both real and perceived abuses by taxpayers, the Internal Revenue Service (IRS) has repeatedly questioned the validity of FLP transactions and caused setbacks to taxpayers and their advisors.

FLPs are frequently valued at a discount for lack of marketability which typically ranges between 20% to 40%, and a discount for lack of control which typically ranges between 0% to 10%.

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