Conscientious estate planning in light of impending IRS regulations

Hartman-Ben-OPTBy Ben Hartman
Special to Elegant Island Living

The IRS is expected to introduce new regulations, possibly as soon as this fall, that may curtail one way that families significantly reduce their tax burdens as they pass wealth from one generation to the next. The new regulations would impact the valuation of family limited partnerships and limited liability companies, which have long been established tools for reducing the tax burden on the intergenerational transfer of assets, providing for asset protection and for management of family assets.

The historic approach has been for a set of parents to establish a family limited partnership, with the couple as general partners. The partnership becomes the owner of a family business or other family assets, and the parents then make gifts of limited partnership interests to their children. Family partnerships provide some degree of asset protection, a framework for keeping family assets in the family, and a mechanism for management oversight of family assets.

The real estate planning benefit of this arrangement, however, is in the fact that the children receive limited partner interests. A limited partner interest conveys ownership of assets but does not have voting rights in the partnership. This lack of control, and the attendant reduced marketability (because of transfer restrictions), has led the IRS to approve discounted valuation of them and thus a lower tax burden. The discounts on these limited partner interests have historically been between 30 and 40 percent, which in the case of large estates could represent a substantial reduction in tax burden.

While the IRS and Treasury Department have reluctantly approved or altered discounted valuations in the past, it has been indicated by Treasury officials that regulations will soon tighten. The law currently requires that a partnership must serve a legitimate business interest. The language in the tax code that permits discounted valuations is vague and subject to reinterpretation by the IRS.

These discounted valuations have been a valuable part of estate planning for years, particularly when the client has reached or exceeded the lifetime gift-tax exclusion (currently $5.43 million for individuals and $10.86 million for couples). It is entirely possible, however, that new IRS regulations will be handed down soon that subject discounted valuations to additional scrutiny and/or legal requirements. Since these regulations will likely apply to limited partnerships and limited liability companies, there is also some concern that they may be overbroad or overly burdensome on entities that were not their intended targets.

For individuals whose estate is sizable enough to be affected, there is no better time than the present to take appropriate steps to minimize one’s tax burden to the full extent of the law. An experienced estate planner can help preserve family assets and keep them as intact as possible.