Family Limited Partnerships - Client Letter, Following Completed Gift Rules
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Dear Parent and Family Limited Partnership Member
This letter will cover the following items. At the end of the letter I have attached some material which will, although technical and detailed in nature, cite the reasons for my statements of concern about the Incomplete Gift Issue and the Indirect Gift Issue.
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Indirect Gifts Solution |
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Incomplete Gifts Solution |
FLP Comments and Advice
Indirect Gifts Issue and Solution
The Internal Revenue Service includes indirect gifts when computing the annual exclusion or the amount to apply the lifetime credit to.
An indirect gift is any type of transfer of any type of property that would add net worth to a party other than the grantor. This definition may seem outrageously broad or seem as though it is not a definition because of the broad definition. Therefore, an example is owed to you and will assist with the Government’s position on this type of transaction. After the sample the FLP activity in 1998 will be related to the sample and the definition.
EXAMPLE: Father owns 51% of the shares of X Corp. and Daughter owns 49% of the shares of X Corp. Father makes a $100,000 capital contribution to X Corp., but does not anticipate receiving additional shares or a promissory note from X Corp. to reflect that cash transfer. Further, X Corp. does not demand a proportionate contribution from Daughter, and Daughter has no intention to voluntarily contribute a proportionate amount. The net effect of this arrangement is that the equity value of Daughter's shares in X Corp. has increased by $49,000. This is a gift indirectly made by Father to Daughter.
You contributed about $7,500 in cash or mutual fund balances to Family LP in 1998. Child 1 contributed $3,000, but Child 2 contributed $0. These transactions created indirect gifts. This is so, because if the partnership were to be terminated, assets distributed, or the FLP has earnings, there will be an increase in the amount owing to the non-contributing partners without any consideration furnished by those partners. Furthermore most of the states have adopted the Uniform Limited Partnership Act or the state's statute is modeled very closely to the uniform model. Why is this important to know?
Why the Partnership Law Impacts Your Actions |
| The partners in a partnership share the partnership assets according to the capital sharing ratio. Whenever any asset is added to the partnership holdings, all the partners possess a share of the new addition. Therefore, if a partner deposits money or transfers ownership of property to the FLP without the FLP paying for the cash or other property, the entire set of FLP partners take their proportional share of the new cash or property. This constitutes a gift to the other partners.
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EXAMPLE: Make a scenario with only two partners, each has contributed $5,000 and each has a 50% ownership.
Partner A contributes an additional $10,000 without an increase in the % of capital or profits. Partner B does not contribute any property or money although retains a 50% interest in the capital and profits. The money contributed by both partners is in a checking account bearing the partnership name and does not earn any interest or incur any liabilities.
The new balance is now a total of $20,000.
The partners decide to terminate the partnership without conducting any business.
Partner A has 50% and partner B has 50%.
Partner A receives $10,000 and partner B receives $10,000. Partner B received the benefit of the added contribution by Partner A.
Refrain from making contributions to the FLP without taking into consideration the annual exclusion available.
A second method is to consider increasing the share of capital, profit and loss by the amount of the contribution of the contributing partner. This will have a tendency to reverse the trend of increasing the share of the children. Furthermore, I will need some time to overview the partnership agreement in relation to the LP’s contributing money and increasing the LP share of the capital. Usually, the LP will not be required to contribute money or property and therefore the additional contributions although voluntary must follow the outline of the agreement.
To constitute a gift for federal gift tax purposes, the transfer must be complete. A gift is complete if the donor has parted with dominion and control so as to have no power to change its disposition, whether for his or her own benefit or for the benefit of another. To determine whether a gift has been completed, an examination usually must be made of both the terms of the gift transfer and the applicable local transfer law.
The Internal Revenue Service has challenged Family Limited Partnerships specifically. Many of the FLP’s are designed so that the GP (usually the contributing partner) has total management control of the FLP. Furthermore, it is common for the GP to refrain from making actual distributions of the cash. It is here the Internal Revenue Service becomes successful in its challenge.
Please read the Internal Revenue Service challenge at the end of the letter for a more complete dissertation on this subject. I have furnished you a copy of this type of challenge previously and if you have previously read, understood and recollect the content of the letter to you, there is no reason to read the section following the signature portion of this letter.
In order to establish more evidence the transferring of the shares of the capital of the FLP you are advised to make a cash distribution to the partners in the FLP.
Solution Hint |
| Retaining control and ownership by actions will only defeat your purpose. Relinquishing dominion and control over the transferred family limited partnerships will make a valid argument the gift qualified for a completed gift. Distribution of cash on an annual basis is one of the actions you should take. If the person you gave the family limited partnership interest to is a minor, perhaps less than annually will not disqualify your actions. I will strongly urge at least every other year you distribute some of the cash earnings to the minor's account outside the family limited partnership.
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Since the Internal Revenue Service is continuing to attack the FLP, one cannot be certain the FLP will be successfully upheld even though cash distributions are made.
I have not observed any challenge of the FLP where cash distributions were made and the challenge was made by the Government based upon the amount of the distribution in relation to the amount of income being apportioned to the LP’s, including the non-contributing LP’s. I will warn you that amounts of distribution so small as to warrant a challenge by the Government that the cash distributions were minuscule in relation to the amount of income shown on the K1 is a possibility. Therefore, do not make the distributions too small in relation to the income.
The LP’s certainly have a choice to make more investments in the FLP once the distributions have been made.
Bob Parrish CPABob Parrish CPA PC
For the firm,
Bob Parrish CPA
Last Date Saved: 04/19/99 1:45 PM Last Saved By: Bob Parrish CPA
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