Wealthy families that set up family limited partnerships (FLP) years ago as an estate tax planning tool may be wondering if that move needs to be reconsidered.
As a result of the increased federal exemption amount ($11.18 million) that went into effect in 2018, fewer estates will be subject to federal estate taxes. It’s estimated that only 1,800 estates will be subject to estate taxes this year, down from 5,000 in 2017 and 52,000 in 2000, when the exemption was $675,000, according to Forbes’ Ashlea Ebeling, sourcing the Joint Committee on Taxation.
A reader whose estate is below the current exemption wants guidance. (I’ve adjusted the details to preserve confidentiality.) “Don” set up an FLP in 2004 to hold real estate, which was valued at $4 million at the time. Don gifted 90 percent of the real estate to the FLP for the benefit of each of his three daughters, retaining a 10 percent interest for himself.
Don is wondering if it’s smart to keep the FLP alive, and if not, what to do about it.
On the positive side, by gifting 90 percent to his daughters, the FLP removed 90 percent of $4 million from his estate, which was a good result back in 2004.
On the negative side, administrative efforts are tedious and costly. When he dies, the step up in basis on the real estate would be limited to his FLP share (10 percent).
If there are no federal estate tax benefits under current law, why not close down the FLP?
This is a good question, and there are more questions right behind it.
If the FLP is closed, what else needs to be done to get a full step up (100 percent versus 10 percent) for his daughters so they can sell the property without suffering capital gains taxes? Closing down the FLP is not enough, because each partner would end up owning his or her share outright with the same result.
What are the options to achieve the goal? Can a gift be undone? What are the tax consequences, what are the risks, and what are the potential rewards?
What would need to be done? Are there state estate tax benefits to status quo? And what about the fact that the federal estate tax exemption is due to expire in 2025?
Plus, even if nothing is done, there is always the chance that the IRS, after the FLP grantor dies, will question whether the grantor retained too much control of the FLP. If the IRS wins the argument, the real estate would be included in Don’s estate when he dies. The result?
No federal estate tax if death occurs in 2018 because his estate plus the full value of the real estate would be less than $11.18 million. Plus, a step up in basis to the date-of-death valuation.
These are questions that need to be posed to an attorney who is an estate tax and FLP expert.
“This is a complicated area of the law, not for a practitioner new to FLPs,” explained tax attorney Marissa Dungey, partner with Withers Bergman LLP. “There are pitfalls if you move forward without proper advice.” She said that when interviewing, ask the lawyer: “Do you consider yourself a tax adviser?”
One more point: It’s not hard to dissolve an FLP. What’s hard is to consider all the consequences and plan for alternatives.
Attorney Gary Botwinick of Einhorn Harris, Ascher, Barbarito & Frost PC, of Denville, N.J., makes the point: “This is a very limited set of facts. Once the entity is dissolved, Don’s daughters would own 90 percent of the entity, and this would give them control. Additionally, because the asset owned by the FLP is real estate, if it is dissolved, each of the daughters, individually, would have certain rights, which could include a right of partition. This means that any one of the daughters could force a sale of the real estate.”
Avoiding surprises is the goal.
Should you undo an FLP? Perhaps; perhaps not.
One thing is for sure: Anytime your goals change, revisit your planning. And if you’re dealing with an FLP, call in the experts before taking any action.