Suppose you are a wealthy professional wishing to pass on your financial legacy to your children and grandchildren. Without careful planning, taxes could eat up a large portion of your estate.
One way to reduce estate taxes is to reduce the estate itself by giving away property before death. There are some drawbacks to this method, including gift taxes and loss of control over the property. No gift taxes will be owed, however, as long as each recipient of a gift receives no more than $15,000 (for 2018) in a single year. Yet, this process can be laborious if it takes years to liquidate your estate. Furthermore, it leaves your heirs at risk should you die before all targeted assets are distributed.
In addition, many people are reluctant to give up control of their assets. After many years of building up financial resources, heads of households are concerned that a transfer of wealth to young family members will decrease the younger generation’s incentive to achieve success through hard work. The younger members of the family also may be inexperienced in managing property or may have extensive debt. Thus, avoiding estate taxes may be of less concern than dissipation of the family business, either through mismanagement or attachment by the donee’s creditors.
Until recently, tax planners could offer few solutions to such problems. However, there is now a way to allow more property to be given away as gifts to family members without incurring gift taxes, thanks to a new ruling by the Internal Revenue Service. The method is a family limited partnership, which can be structured so that the younger family members have no control over partnership assets and are forbidden from selling their partnership interests.
This no-sell provision also protects the younger generation’s partnership interest from creditors, including an ex-spouse in a divorce proceeding, though creditors may attach any income distributed from the partnership.
A limited partnership is not the best solution in every circumstance, however. First, family limited partnerships must have a valid business purpose. Avoid any circumstance that implies that your only motive in creating the limited partnership is to protect the assets from creditors or estate taxes. In addition, as a general partner, you may wish to share some management responsibilities with your children, the limited partners, as you look forward to retirement. In that event, care must be taken to avoid centralizing management to such a degree that the partnership is recharacterized as a corporation.
Likewise, if you are very risk adverse and create a corporation or limited liability company to serve as your general partner, the resultant limited liability can threaten the partnership status of the partnership. Moreover, the gift method of estate reduction may be inappropriate for your appreciated property. In such a situation, you may be better off passing the property at death in order to allow your heirs a stepped-up basis, despite the fact that estate taxes will be owed.
In spite of these limitations, however, a family limited partnership can be a valuable part of many estate plans. Call our office today to learn more and discover whether it is right for you.