Wrestle Mania

June 2, 2008

Wrestle Mania - By Joseph B. Darby III , Paul McCawley

Some things just set people off: wave a red flag at a bull, or tell a hard-core professional wrestling fan that you think the WWE is a complete fake, or walk into a sports bar in Boston wearing a Yankees hat and start talking serious New York smack to a die-hard Red Sox fan.

Or, if you REALLY want to start a WrestleMania, all you have to do is file an estate or gift tax return with the IRS and claim a discount for an interest in a family limited partnership (FLP).

For the last 15 years, taxpayers and the IRS have been engaged in a kind of Texas Steel Cage Death Match over the gift and estate tax consequences of an FLP. Thus far, it has been a hard-fought and surprisingly even fight. On the one hand, taxpayers have used this popular tax-planning technique to cut estate and gift taxes dramatically, while passing a greater portion of the family wealth on to successor generations. On the other hand, the IRS has pushed back hard, and after an early period of inept and feckless failures, has become increasingly canny and successful in attacking FLPs and limiting their effectiveness.

Conflict, of course, is inevitable. Wealthy taxpayers want to pay as little in taxes as possible, while the IRS would like to collect as much tax as it can. That is not news. What makes the contest fascinating is the amount of money at stake, and the sophisticated skills of the contestants as they face-off in the proverbial ring.

This battle is not going to end anytime soon: Taxpayers can be counted on not to give up a dollar more in taxes than is required; Uncle Sam, meanwhile, has no intention of saying "uncle."

An FLP, even though created for a variety of bona fide business reasons, does have undeniable benefits under tax law. First and foremost, FLP interests can be fragmented and easily transferred, and the value of those interests can be eligible for substantial discounts. The IRS distinguishes limited partnerships that hold securities and other investment assets from a real estate partnership or a partnership that carries on an active business. In the former case, assuming that there is substance to the FLP, that formalities are observed and that administration is meaningful and consistent, the IRS will grudgingly give a discount in the 15% area, while in the case of a more active and meaningful partnership (for example, one engaged in the ownership and management of real estate or the operation of a business), the IRS has accepted discounts of 35% or more on audit.

Potential Benefits Of An FLP

FLPs are used by families and their advisors to accomplish a wide variety of legitimate family objectives, including the following:

1. An FLP allows for a pooling of family resources that lets everyone enjoy investment diversification and economies of scale.
2. It allows for centralized management and control over what can be a diverse portfolio of family assets.
3. As a partnership, it allows flexibility in planning and structure not available through a corporation, trust or other business entity.
4. Assets such as real estate can be held in an FLP (or even reconsolidated in one), so the fractionalization occurs when the interests in the FLP are handed out, and not in the underlying asset. This can preserve the value of large or important assets, particularly real estate.
5. FLPs can provide significant asset protection benefits to the partners.
6. FLPs can ease the burdens of administration and reduce the costs in probating an estate, because there is only a single partnership interest instead of many separate assets in the estate.
7. There are federal estate and gift tax benefits in an FLP, including potential valuation discounts based on lack of control (the "minority interest" discount) and lack of marketability (the "marketability" discount).
Disagreements are the spice of life: In the words of Mark Twain, "It is not best that we should all think alike; it is a difference of opinion that makes horse races."  

At the moment, this particular disagreement makes for one heck of a lot of tax court litigation.

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