FLP Care And Maintenance

December 2008

FLP Care And Maintenance - By Edward A. Renn , N. Todd Angkatavanich - 12/4/2008

Family Limited Partnerships and Family Limited Liability Companies ("FLPs")  have grown in popularity over the last decade and, as a result, have come under IRS scrutiny. One of the keys to withstanding this scrutiny, however, may be a resource that's already at the disposal of many wealthy families: the family office.

Recent tax court cases have shown that the ongoing administration of FLPs is as important as making sure the transaction was properly structured at the outset. The family office is a natural fit for ensuring such administration because of its day-to-day involvement with family members and their assets, businesses and investments.

Using a family office for FLP administration may be for some a relatively new concept, partly because FLPs are considered to be the domain of tax lawyers. Yet while it's true that family offices may lack the legal expertise to set up an FLP, they can be valuable resources in both the formation and administrative stages.

The Importance Of Active FLP Maintenance
FLPs have become popular because of their ability to provide a structure to manage family assets, protect against creditor claims and reduce estate and gift taxes through valuation discounts.

Simply stated, if a parent contributes assets into an FLP in exchange for partnership interests, the partnership interests may be worth less than the assets for gift or estate tax purposes. This is due to the fact that a buyer would likely not pay as much for partnership interests in an FLP as he would for unrestricted assets.

There was little guidance or case law on how to create or administer an FLP until about 10 years ago.  Before then, practitioners relied on cases that acknowledged the possibility of a valuation discount upon the transfer of minority interests in closely held entities. As FLPs became more popular, however, estate planners, clients and family offices were often at a loss as to how to operate these vehicles so the IRS would respect the transaction and honor the valuation discounts.

What can a family office do in order to improve the odds, or possibly ensure, that an FLP will be respected for estate and gift tax purposes?  Thankfully, FLP jurisprudence has come a long way over the past decade and we now have numerous court opinions that provide a "roadmap" to properly administer these vehicles.  Family offices bring an intimate understanding of the interpersonal dynamics, businesses and investments of their family clients, putting them in an excellent position to guide clients through the FLP maze of "do's" and "don'ts."

Recent case law provides other compelling reasons to bring family offices into FLP administration.

Many FLP practitioners used to believe the magic of the FLP was in its formation documents. Numerous "bad facts" cases, however, have since made it clear that the FLP is not a "set it and forget it" estate planning technique. Proper FLP formation is still essential, but the partners must actively maintain these vehicles if they are to achieve the desired results.

As a common practice, FLP practitioners send out correspondence to clients explaining the importance of maintaining and properly administering the FLP. The advice, unfortunately, often goes unheeded. Clients get on with their busy and complex lives and often neglect their fledgling FLP structures-a mistake that can lead to IRS scrutiny and significant estate tax exposure. Family offices can fill this administrative void because they are equipped to handle day-to-day FLP maintenance. Family offices can often administer an FLP more efficiently than the family or the attorney who put the structure in place because they are organized, staffed and trained to engage in exactly this kind of oversight.

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