47.5% Discount for Post-Mortem Family Limited Partnership

Posted on September 8, 2009 by Bryan Howard

Family limited partnerships (or LLCs) are often used to obtain valuation discounts for estate and gift tax purposes. Appraisers typically conclude that the fair market value of an interest in a family limited partnership (“FLP”) is at least 35% less than the value of the assets owned by the FLP.

The IRS dislikes these discounts and has successfully challenged the discounts in several court decisions. As a general rule, the taxpayers were "sloppy" in the cases that the IRS has won. Errors were made either in funding, distributions, or record keeping.

When the FLP is properly funded and administered, taxpayers are able to substantiate the discounts. For every case in which the IRS has successfully disallowed discounts, there are many others where the court approved a discount or the IRS agreed to a discount without going to trial.

A case in point is the recent Rayford L. Keller et al v. United States decision. Mrs. Williams was in the hospital, dying from cancer. Six days before her death, she signed documents to establish an FLP to be funded with $240 million of bonds and $10 million cash.

The assets were not transferred to the FLP until one year after she died. Nevertheless, the Court ruled that her family was entitled to a 47.5% discount on the value of the bonds and cash that were transferred to the FLP.

I do not recommend waiting until death is imminent to establish an FLP. It is far better to establish the FLP when you have several years to live, and then to make gifts or sales of FLP interests when that is appropriate.

Detailed summary of Keller case by Steve Akers of Bessemer Trust Company, N.A.

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529 Accounts Not Always Good Fit for Affluent Families

Posted on August 31, 2009 by Bryan Howard

529 Accounts allow a family to set aside funds for the education of their children or grandchildren without having to pay income tax on the earnings of the plan. These accounts work well for the great majority of families. However, I often discourage my clients from establishing 529 accounts.

In order to avoid paying income tax on the earnings of the 529 account, the funds in the account must be used to pay for expenses of attending college. Tuition accounts for the largest portion of these expenses.

Federal and state gift tax laws allow individuals to pay tuition for another individual without such payment being considered a taxable gift. Tuition payments allow parents and grandparents to reduce the amount of their estate that will be subject to estate taxes upon their death.

Assume that a wealthy grandparent makes gifts to a 529 account for the benefit of a grandchild. Gifts by the grandparent to the 529 account are considered taxable gifts. Generally, the grandparent uses the $13,000 per year annual gift tax exclusion when making gifts to a 529 account.

When the grandchild attends college, the 529 account will be used to pay for the grandchild’s college expenses. The net result of the above example is that the grandparent “lost” the opportunity to make tax-free gifts of the grandchild’s tuition.

If the annual exclusion gifts to the 529 account had instead been made to a traditional brokerage account for the grandchild, the grandparent could have paid tuition without utilizing the funds in the brokerage account. The grandparent’s taxable estate would be reduced and the grandchild would have funds that could be used to make a down payment on a house or to supplement the child’s cash flow when entering the work force.

It is true that income taxes would have been paid on the earnings of the traditional brokerage account. However, this income tax cost does not offset the estate tax savings from being able to make a tax-free gift of tuition expenses. Furthermore, 529 accounts have internal fees and are restricted as to investment choices. These fees and investment limitations somewhat dilute the income tax savings associated with 529 accounts.

Affluent families should evaluate the overall tax ramifications before funding a 529 account to fund a child or grandchild’s college education.

For more information on 529 accounts, you can visit this link.
 

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