Wealthy Use Family Partnerships in Absence of Gift-Tax Exemption

July 10, 2012 — 1 Comment

The expiration of the $5.12 million gift tax exemption is set for the end of 2012. As a result, wealthy families are seeking to centralize the management of their real estate and other assets by creating a family limited partnership. However, not all wealthy families should rush to set up partnerships because they can be egregious ventures as well.

Let’s take a look at what family partnerships do and what they try to accomplish. They are entities that are designed to hold family assets like marketable securities, real estate, and operating businesses. The Partnership Agreement can be drafted for lifetime transfers of Partnership interests in addition to transfers upon an individual’s death to his/her descendants. Perhaps the most attractive part of family partnerships is the ability to discount the value of assets put into the partnership because the shares distributed are less liquid considering only a family member can buy them.

This is a great method for those families who know what they are doing. Where this business formation could go wrong is by aggressively putting in and discounting monies and securities in the partnership. Many families may try to put all their assets into the family partnership and not worry about taxes, however the IRS can easily catch on.

“The I.R.S. has been very selective in litigating only the most egregious scenarios,” Jason Cain of Credit Suisse Private Bank said. “They have gone after $6 million families that put all of their assets into a family partnership and then treated it as their checking account.”

The primary purpose of a family partnership is to have a legitimate business run by legitimate family members. Many cases seen by the IRS are related to families who have set up partnerships to avoid estate taxes.

A successful example is with the Rice family in Texas. Brown Rice, a businessman, said he has reaped extraordinary financial benefits from a financial limited partnership that his father created in 1992. According to Rice, from May 1992 to May 2011, the entity has paid out distributions worth 166% of what was originally put into it and 82% of the principal remaining. Most importantly the partnership’s function is not purely for tax purposes – it has a series of business interests including mineral rights, real estate, and royalties from oil and gas. It also functions as an investment vehicle into small companies.

Family partnerships can be a great tool to centralize a family’s wealth and get minor tax breaks. However, they should be used responsibly and within the confines of the legal system as to ensure the family’s financial security from generation to generation.

JDKatz, P.C. is a full-service law firm focused on tax law and estate planning. We are dedicated to minimizing your existing liability and risks while providing valuable tax planning to streamline your tax issues in the future. Please call us at 301-913-2948 to schedule an appointment to meet with one of our trusted attorneys.

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