Family Limited Partnerships

Family Limited Partnerships

This memorandum is intended to be a reminder of the importance of proper management and operation of your Family Limited Partnership. In order to preserve the estate tax benefits and creditor protection that can be provided by your Family Limited Partnership, it is extremely important that you follow the guidelines described in this memorandum.

This is a standard memorandum and will not necessarily apply to all clients. Nevertheless, virtually every client of ours with a Limited Partnership needs to be aware of these rules.

Your Family Limited Partnership is a separate legal entity, and must be treated as such. While the case law on valuation discounts with respect to Family Limited Partnerships has generally been extremely positive, there have been several cases where the taxpayers failed to adhere to the necessary legal formalities and ignored the Partnership structure, with disastrous results. Here are some do’s and don’ts in this regard:

Don’t use the partnership account as your own personal checkbook. These funds belong to the Partnership and should only be used to pay partnership related items. If you need to obtain funds from the Partnership, a pro rata distribution will usually need tobe made to all of the partners. This requirement is discussed in more detail below.

Don’t contribute personal use items to the Partnership and retain the use of those items without paying fair market value to the Partnership for their use. Any implied agreement whereby you can use partnership assets like the vacation home without paying fair market value rent can result in the entire limited partnership being subject to federal estate tax. This was the result that one taxpayer recently experienced in Tax Court.

Don’t make distributions from the Partnership that are not pro rata to the ownership to the ownership percentage interests as of the date of distribution. For example, if your Partnership is owned 1% by a corporate General Partner which you own, 79% by your Living Trust, and 20% by an irrevocable Gifting Trust, and you wish to receive $10,000 from the Partnership, then a total distribution of $12,500 will need to be made from the Partnership, of which $125 will be paid to the Corporation (and may immediately thereafter redistributed to you if you own the Corporation), $9,875 will be paid to your Living Trust, and $2,500 will be paid to the Gifting Trust. Please notify us or your CPA if you intend to make a distribution from the Partnership. We have standard forms that can be adapted to document that all distributions were pro rata.

If a distribution to all partners is not desired, then any withdrawal of funds from the Partnership may need to be documented as a loan, with the appropriate promissory note and other legal papers executed and kept on hand. If a loan is made, repayment of the loan should be made pursuant to the terms of the promissory note.

If you are rendering valuable services to the Partnership, such as management of any real estate assets, you may receive compensation for your services. If you are paid compensation, then the appropriate self-employment taxes need to be paid on the amount so received.

Please do notify us or your CPA before you make any additional contributions to the Partnership, or follow instructions you have been given, so that the appropriate adjustments in the ownership in the Partnership can be documented. We have a standard Contribution Agreement that can be used for this purpose.

Do contact us prior to year-end if you wish to make annual gifts of partnership interests to your beneficiaries and have not already done so. We have an Assignment of Limited Partnership Interest form that should be executed to document any such transfer. Because most clients generally make gifts of partnership interests effective December 31/January 1, and because it is impossible to know the exact value of the Partnership assets as of December 31 prior to the end of the year, we can prepare a letter of instructions instructing us to fill the appropriate to fill the appropriate percentage based on a desired fair market value of the interest transferred and the fair market value of the partnership assets as to December 31. Just because a gift is reported to have been made to the IRS on tax returns does not mean that it will be respected unless there has been proper documentation executed by appropriate partners. We therefore do need to be contacted when gifts or transfers of ownership interests have been made to help properly document this.

When you transfer an interest in the Partnership, if and to the extent that the gift, after application of the appropriate valuation discount and combined with other gifts to the donee during the calendar year, exceeds $13,000 ($26,000 if made by a married couple), then a federal gift tax return will need to be filed. As a technical matter, a new valuation appraisal report should be obtained for each gift, and a copy of the appraisal would be filed with the federal gift tax return. Many clients, however, have simply obtained a valuation appraisal on the first gift, and have used this appraisal for subsequent gifts as well after adjusting for differences in the fair market value of the Partnership assets. We have to recommend that new valuation appraisal reports be obtained whenever there is a taxable gift that is required to be reported.

Besides keeping our offices posted, we think that the best way to keep a Limited Partnership organized is to confer with your accountant annually, not only as to the partnership income tax return and the gift tax return, but also to ask and answer the question…are we doing everything right?

We have to assume that clients are doing everything right or that they will let us know if they need assistance in any manner, unless we are told to the contrary. Please call if you have any questions.

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