The
Family Limited Partnership Tax Bulletin
October
19, 2000
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Friday, November 10, 2000 06:11 PM
Text
1. IRA Investing In A FLP: Can Individual
Retirement Accounts (IRA) be invested in Family Limited Partnerships? READ IT
2. Hidden Dangers of Transfers to the FLP Subsequent
to Original Funding: The legal counsel cannot expend the time to monitor the
client monthly or in some cases annually. Therefore the legal counsel is
advised to be certain the CPA understands or recommend a CPA for the monitoring
of the Family Limited Partnership. As I am familiar with the FLP I am
writing, to you, a description of one of procedures I perform for the tax
preparation of the FLP. READ IT
3. IRS's Claim for Post Petition Interest Not Entitled
to First Priority Status. READ IT
4. IRS Refund Freeze Violated Bankruptcy Stay; Damages
Awarded. READ IT
5. Second Mortgages Are Avoided in Bankruptcy. READ IT
1. Can Individual Retirement
Accounts (IRA) be invested in Family Limited Partnerships?
An advisory opinion by the Department of Labor suggests that this could be done.
The opinion says that the transaction would not violate §4975(c)(1)(A) of the Tax Code, which prohibits an IRA from exchanging property with a "disqualified person." However, the Department declined to rule on whether the transaction violated two other provisions of the Code.
Experts tell Lawyers Weekly USA that investing an IRA in an FLP would allow clients to get the same "valuation discounts" for their IRA assets that they get for other assets.
 Should Clients Invest IRAs in Family Limited Partnerships?By James L. Dam Published in News Story Lawyers Weekly USA Estate planning clients may now be able to invest their IRAs in family
limited partnerships, under an advisory opinion by the Department of
Labor.
This may allow clients to get the same "valuation discounts"
for their IRA assets that they get for other assets, experts tell Lawyers
Weekly USA.
Such discounts could greatly reduce the income tax on IRA
distributions, including the tax on a conversion of the IRA to a Roth IRA,
as well as reduce estate taxes.
Estate planners have "kicked around" the idea of investing
IRAs in family limited partnerships for years, but generally have not been
willing to try it, says attorney Paul Hood of Covington, La.
"This ruling shows that it's possible," says Boston attorney
Natalie Choate, author of Life and Death Planning for Retirement
Benefits.
"It's an amazing ruling," says Seymour Goldberg of Garden
City, N.Y., author of J.K. Lasser's How to Protect Your Retirement
Savings From the IRS.
Some planners "are just salivating over it," says attorney
Noel Ice of Fort Worth, Texas.
However, it's still not clear exactly when the investments will be
permitted, experts warn.
And if an investment were found to be illegal, the entire IRA would be
disqualified, meaning that all its assets would be immediately taxed as if
they had been paid out to the owner.
"These are still uncharted waters, and while the upside is
terrific, the downside is draconian," says Wichita, Kan., attorney
Timothy O'Sullivan.
As a result, "Most people are still going to be wary of
this," says Ice.
On the other hand, because the potential benefits are so great,
"There will be those who will argue that anyone who doesn't do it to
get discounts is nuts," says Hood.
The advisory opinion involved a family partnership that owned only
marketable securities. It apparently had been formed so that the family
members' combined investments would meet the minimum amount required by a
certain investment manager.
One individual also owned a $500,000 IRA which he wanted to have
managed too. But the manager would agree to handle it only if the funds
were owned by the partnership. The family member proposed having his IRA
contribute its funds to the partnership in exchange for a limited
partnership interest, and asked the Department of Labor whether this would
be legal.
The Department ruled that the transaction would not violate a provision
of the Tax Code that prohibits an IRA from exchanging property with a
"disqualified person." (Sect. 4975(c)(1)(A).)
Applying the Code's complicated test for this, it said that while the
IRA-owner and his family members were "disqualified persons,"
the partnership itself was not.
The opinion treats the transaction as "strictly between the IRA
administrator and the partnership," says Jerry Kasner of Grass
Valley, Calif., a CPA and a former law professor at the University of
Santa Clara. "It does not look through the partnership to treat it as
a transaction involving individual family members."
However, the Department declined to rule on whether the transaction
violated two other provisions of the Code that prohibit any transaction in
which (1) the IRA assets are used "by or for the benefit of" a
disqualified person, or (2) the IRA-owner "deals with" the
assets "in his own interest or for his own account." (Sect.
4975(c)(1)(D) and (E).)
It said that whether the transaction would violate these provisions
"raises questions of a factual nature upon which the Department will
not issue an opinion."
The Department noted that it might find a violation of these provisions
if the IRA-owner received any compensation from the partnership or would
otherwise benefit from the transaction such that there might be a conflict
of interest.
Clients may be able to "discount" the value of IRA assets for
tax purposes by using this same transaction – directing their IRA to
exchange stocks, bonds, cash or other property for interests in a family
limited partnership. ...
Experts say that it's still unclear whether the following circumstances
would be required for an IRA's investment in a family limited partnership
to be permitted:
The partnership owns only marketable securities;
In addition, it's not clear whether an IRA investment made for the
purpose of obtaining valuation discounts would be illegal as a use of
the IRA assets for the benefit of the IRA-owner, as opposed to the
IRA, or for the benefit of the IRA-owner's family members.
The Tax Code's rules in this area are not only unclear but very
complicated with cross-references to cross-references, says Ice.
"They'll give you a headache."
And because violating a rule means the entire IRA will be
disqualified, "You have to thread the needle of [the rules] and
be absolutely sure you've threaded them," says New York estate
planning attorney Bruce Steiner.
The danger can be minimized by splitting an IRA into two IRAs and
investing only one of them in a family limited partnership. If the
investment is found to be illegal, only the invested IRA would be
disqualified.
A problem, however, is that the size of the investment may need to
be quite large for it to be worthwhile, because of the costs involved.
The biggest cost will generally be an annual appraisal of the value
of the IRA's limited partnership interest for the purpose of
calculating the IRA's minimum required distribution.
"You will have a situation whereby the IRA has to be valued
each year, and possibly a second time during the year if the
distribution is made at another point," says Barry Picker, a CPA
in Brooklyn, N.Y.
Unless the investment is very large, the appraisals "may be
too expensive to make this a useful planning tool," says attorney
Dennis Williams of Maumee, Ohio.
Appraisal costs, however, may be relatively small for an older
client or someone who is planning to convert their IRA to a Roth IRA,
as there may not be a need for appraisals over many years, says
Williams.
But the costs in setting up the family limited partnership and
making the investment may also be substantial.
A trustee or custodian willing to hold the investment may charge a
high fee for doing so, says Hood. In addition, the contract with the
trustee or custodian may need to be specially drafted, he says.
Another way to minimize the danger might be to obtain a Department
of Labor ruling – either an advisory opinion or a "prohibited
transaction exemption" – in your case.
However, it's likely that, as in the new ruling, the Department
would decline to rule on whether the transaction violates Sections
4975(c)(1)(D) and (E), says Carol Brown, an employee benefits attorney
in Boston.
Also, the legal fees for obtaining a ruling may be as high as
$15,000, says Brown.
Besides discounts, another benefit of investing IRA funds in a
family limited partnership is that it may give a client with few
non-IRA assets the ability to invest in a venture with family members,
says Andrew Willms, an estate planning attorney in Thiensville, Wis.
Also, it might allow a client to use IRA funds to purchase life
insurance, says Willms. IRAs are not allowed to own life insurance
directly, but they might be able to contribute funds to a limited
partnership that owns a policy, he says.
In states where IRAs are not already protected from creditors,
investing their assets in a family limited partnership might also
provide some asset protection, says Christopher Bray, a CPA in Pepper
Pike, Ohio.
Instead of getting the underlying assets that the IRA contributed
to the family limited partnership, creditors may be limited to a
"charging order," under which they would only be entitled to
any profit that the family limited partnership actually distributes to
the IRA.
On the issue of whether there is a violation of the Tax Code's
rules for IRA investments, the IRS is bound by the rulings of the
Department of Labor, lawyers say.
Another worry, however, is that as to discounts that are claimed
for an IRA's interests in a family limited partnership, the IRS may be
extremely uncooperative.
"The IRS does not like family limited partnerships in
'regular' estate planning," says Williams. "But they ain't
seen nothing yet if this can be used in an IRA."
The decision is Advisory Opinion 2000-10A. |
July 27, 2000
|
Hugh Janow |
2000 - 10A |
|
Dear Mr. Janow:
This is in response to your request for an advisory opinion under section 4975 of the Internal Revenue Code (Code). Specifically, you ask whether allowing the owner of an IRA to direct the IRA to invest in a limited partnership, in which relatives and the IRA owner in his individual capacity are partners, will violate section 4975 of the Code.1
You represent that the Fetner Family Partnership is a New York general partnership that is an investment club (the Partnership), in which Mr. Adler, through a general partnership known as Esponda Associates (Esponda), and various relatives of Mr. Adler invest. Through his investment in Esponda, which is a pass-through partnership, Mr. Adler owns a 12.11 percent interest in the Partnership. Mr. Adler presently owns a 30.38 percent interest in Esponda. The only other partner in Esponda is David Geiger, who is unrelated to Mr. Adler. Esponda currently owns a 39.85 percent interest in the Partnership.
The other current partners of the Partnership are as follows: Steven Adler (Mr. Adler’s son) — 5.25%; Jack Fetner (Mr. Adler’s father-in-law) — 13.44%; Adam Nadel (Mr. Adler’s son’s brother-in-law); Fay Nadel (Mr. Adler’s mother-in-law) — 25.55%; Andrea Raskin (Mr. Adler’s daughter) — 5.33%; Lois Zoldon (Mr. Adler’s sister-in-law) — 7.57%.
The Partnership’s assets are managed by Bernard L. Madoff Investment Securities (Madoff), which is unrelated to Mr. Adler. Madoff requires entities to maintain a minimum capital account. You represent that the Partnership currently has an account with Madoff and has not received any notice that its does not meet minimum capital requirements for investment management by Madoff. The IRA’s assets are not necessary for the Partnership to continue its account with Madoff.
You represent that Leonard Adler intends to open a self-directed individual retirement account (IRA) in the amount of approximately five hundred thousand ($500,000.00) dollars through Retirement Accounts, Inc. of Denver, Colorado. At the time Mr. Adler directs the IRA investment, the Partnership will become a limited Partnership. Mr. Adler will be the only general partner in the Partnership and will own 6.52%. Mr. Adler will not have any investment management functions with respect to the assets of the Partnership.
The limited partners and their percentage ownership interests will be as follows: Andrea Raskin — 1.35%; Steven Adler — 3.07%; Jack Fetner — 3.94%; Fay Nadel — 18.1%; Adam Nadel — 1.77%; Lois Zoldon — 5.55%; David Geiger — 20.31%; IRA of Leonard Adler — 39.38%. Messrs. Adler and Geiger will invest directly in the Partnership in the same percentages as they would have invested through Esponda, instead of investing through Esponda. Esponda will no longer invest in the Partnership.
You further represent that Mr. Adler believes that Madoff would effectively manage assets for the IRA, but that Mr. Adler’s IRA does not meet the minimum capital requirements (currently $1 million) for investment management by Madoff. You represent, however, that Madoff will manage the IRA’s assets if it invests with Madoff through the Partnership, even though the IRA by itself otherwise would not meet the minimum capital requirements. You further represent that all of the assets of the Partnership are liquid marketable securities. You also represent that none of the funds contributed by the IRA is required to be used, or will be used, to liquidate or redeem any other partner’s interest in the Partnership.
Finally, you represent that Mr. Adler does not and will not receive any compensation from the Partnership. He likewise will not receive any compensation as a result of the acquisition by the IRA of its limited partnership interest.
You ask whether the investment by the IRA in the Partnership will give rise to a prohibited transaction under section 4975 of the Code. Section 4975(e)(1) of the Code, in relevant part, defines the term “plan” to include an IRA, described in section 408(a) of the Code. Section 4975(e)(2) of the Code defines “disqualified person,” in relevant part, to include a fiduciary, a relative, and a partnership, of which (or in which) 50 percent or more of the capital interest or profits interest of such partnership is owned directly or indirectly, or held by a fiduciary. Section 4975(e)(3) of the Code defines the term “fiduciary,” in part, to include any person who exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control regarding management or disposition of its assets. In order for a prohibited transaction to occur under section 4975 of the Code, there must be a transaction involving a disqualified person with respect to a plan. Where none of the relationships described in section 4975(e)(2) of the Code are found to exist, an entity would not be a disqualified person with respect to a plan.
Section 4975(c)(1)(A) of the Code prohibits any direct or indirect sale or exchange or leasing, of any property between a plan and a disqualified person. Section 4975(c)(1)(D) of the Code prohibits any direct or indirect transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan. Section 4975(c)(1)(E) of the Code prohibits a fiduciary from dealing with the income or assets of a plan in his or her own interest or for his or her own account. Section 54.4975-6(a)(5) of the Pension Excise Tax Regulations characterizes transactions described in section 4975(c)(1)(E) as involving the use of authority by fiduciaries to cause plans to enter into transactions when those fiduciaries have interests which may affect the exercise of their best judgment as fiduciaries.
As a trustee with investment discretion over the assets of his IRA, Mr. Adler is a fiduciary, and therefore, a disqualified person under section 4975(e)(2) of the Code. Mr. Adler is also a disqualified person in his capacity as the general partner of the Partnership to the extent he exercises discretionary authority over the administration or management of the IRA assets invested in the Partnership. In addition, although Mr. Adler, his son and his daughter are disqualified persons, you represent that the investment transaction is between the Partnership itself and the IRA, and not with Mr. Adler and his family, except as fellow investors in the Partnership. Mr. Adler owns only 6.5 percent of the Partnership, and therefore the Partnership itself is not a disqualified person under section 4975(e)(2)(G) of the Code which defines a disqualified person to include a corporation, partnership or trust or estate of which 50 percent or more of the capital interest is owned directly or indirectly, or held by persons described as fiduciaries.
Based solely on the facts and representations contained in your submissions, it is the opinion of the Department that the IRA’s purchase of an interest in the Partnership would not constitute a transaction described in section 4975(c)(1)(A) of the Code (prohibiting any direct or indirect sale or exchange or leasing of any property between a plan and a disqualified person).
Whether the proposed transaction would violate sections 4975(c)(1)(D) and (E) of the Code raises questions of a factual nature upon which the Department will not issue an opinion. A violation of section 4975(c)(1)(D) and (E) would occur if the transaction was part of an agreement, arrangement or understanding in which the fiduciary caused plan assets to be used in a manner designed to benefit such fiduciary (or any person which such fiduciary had an interest which would affect the exercise of his best judgment as a fiduciary).
In this regard, the Department notes Mr. Adler does not and will not receive any compensation from the Partnership and will not receive any compensation by virtue of the IRA’s investment in the Partnership. However, the Department further notes that if an IRA fiduciary causes the IRA to enter into a transaction where, by the terms or nature of that transaction, a conflict of interest between the IRA and the fiduciary (or persons in which the fiduciary has an interest) exists or will arise in the future, that transaction would violate either 4975(c)(1)(D) or (E) of the Code. Moreover, the fiduciary must not rely upon and cannot be otherwise dependent upon the participation of the IRA in order for the fiduciary (or persons in which the fiduciary has an interest) to undertake or to continue his or her share of the investment. Furthermore, even if at its inception the transaction did not involve a violation, if a divergence of interests develops between the IRA and the fiduciary (or persons in which the fiduciary has an interest), the fiduciary must take steps to eliminate the conflict of interest in order to avoid engaging in a prohibited transaction. Nonetheless, a violation of section 4975(c)(1)(D) or (E) will not occur merely because the fiduciary derives some incidental benefit from a transaction involving IRA assets.
Moreover, the Department notes that by virtue of the contemplated investment by the IRA in the Partnership, there will be significant investment in the Partnership by benefit plan investors. See 29 CFR § 2510.3-101(f). Accordingly, the Partnership will hold “plan assets” within the meaning of that term in the Department’s regulations at 29 CFR § 2510.3-101. As a result, any person who exercises discretionary authority or control with respect to assets of the Partnership will be fiduciary of the IRA and subject to the restrictions of section 4975(c)(1) of the Code, except to the extent a statutory or administrative exemption applies.
This letter constitutes an advisory opinion under ERISA Procedure 76-1, 41 Fed. Reg. 36281 (1976). Accordingly, this letter is issued subject to the provisions of that procedure, including section 10 thereof, relating to the effect of advisory opinions.
Sincerely,
Louis Campagna
Chief, Division of
Fiduciary Interpretations
Office of Regulations
and Interpretations
1 Under Presidential Reorganization Plan No. 4 of 1978, effective December 31, 1978, the authority of the Secretary of the Treasury to issue interpretations regarding section 4975 of the Code has been transferred, with certain exceptions not here relevant, to the Secretary of Labor and the Secretary of the Treasury is bound by the interpretations of the Secretary of Labor pursuant to such authority.
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