The IRS is continuing its attack on Family Limited Partnerships (FLP), often because it is challenging the valuation discounts used with respect to estate planning. Just because the IRS is challenging these entities does not mean that they should no longer be used. Instead, it is important to make sure that your FLP is compliant with all tax laws. Here are some suggestions to avoid any unnecessary IRS scrutiny:
Avoiding IRS Scrutiny
- Establish (and document) a non-tax purpose for each transfer of assets into a FLP. Estate planning and general business and personal asset protection are common non-tax purposes for a FLP. Courts have stated that the motivation must be actual and not merely theoretical.
- Observe all business formalities as set forth in the partnership agreements, including the maintenance of capital accounts, corporate minutes (if needed), general ledgers and a tracking system for all business receipts.
- Avoid commingling personal and business assets in the FLP. This is good advice for
any business entity!
- Avoid making distributions that are not in proportion to the partner's interests. For instance, if one partner has a 25% interest in the FLP and receives a $100 distribution, the other 75% partners should also receive their proportionate share of the remaining $300 in distributions.
- Make sure that you have sufficient personal assets outside of the FLP to meet your day-to-day living expense needs. This means that you should not be relying upon the assets in the FLP for normal living expenses.
Do not transfer assets that you use personally (including your personal residence,
automobiles, vacation homes, etc.) to the FLP unless you are paying fair market rates
to rent these assets. Thus, if your primary residence is in a FLP (and this may not be a good idea due to the potential loss of the capital gains exclusion when you sell), you should determine the fair market rental of your home and pay this over in rent every month to the FLP.