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In order to qualify for the $13,000 annual exclusion, the gift must constitute a present-interest gift.  Unfortunately, several recent court cases have come out which have determined gifts of FLLC interests were not present interest gifts.   First, in Price v Commissioner, T.C. Memo 2010-2 (January 4, 2010), gifts of limited partnership interests by parents to their three children did not constitute present interest gifts because there was no immediate enjoyment of the property gifted.  The recipients had no ability to withdraw their capital accounts because they could not sell their interests without the written consent of all other partners.   Further, there was no enjoyment of income because there was no regular flow of income from the partnership and the distribution of profits was at the discretion of the general partner.

Similarly, in Fisher v. United States of America, Docket #1:08-cv-0908-LIM-TAB, (March 11, 2010), a U.S. District Court in Indiana recently ruled that gifts of LLC interests were gifts of future interests, not present interests and, therefore did not qualify for the annual exclusion because the LLC held undeveloped land and there was no prospect of current distributions.   The LLC at issue owned undeveloped land, and the IRS successfully argued that the children’s right to receive distributions of the LLC’s capital proceeds was contingent on an unknown future event (the sale of the land).  As such, there was no present interest gift.

There are several ways to minimize the risk associated with this issue.  First, clients should use right of first refusals rather than an outright prohibition on transfers of limited partnership interests.  Most partnership and LLC agreements currently have these transfer restrictions and should be amended to take them out.  Second, partnership agreements should be reviewed to make sure donees are not mere assignees.  Mere assignees have limited rights and the Court in Price concluded gifts of assignee interests could not be present interest gifts.  Third, the partnership agreement should be amended to provide an enforceable standard for distributions of income or require distributions of net cash flow (defined to include discretion for reserves).    If possible, partnerships should also make distributions each year.   Finally, the general partner should have a fiduciary duty to limited partners regarding distributions.    While incorporation of all of these items might not prevent an IRS attack, doing so will ensure strong arguments should the IRS raise these issues on audit.

To address some or all of these items in your partnership  or LLC agreement, please contact us.

In Estate of Shurtz, the decedent formed multiple FLP’s and gifted fractional interests to her descendants or trusts for the benefit of her descendants over the course of years.  The FLP’s were formed for valid business reasons, asset protection, management efficiency, and protection of family business from litigation.  The partnership kept detailed financial records, issued K-1s, and filed Form 1065 every year.  Additionally, the partnership held detailed annual meetings to discuss business strategies and its financial positions. 

The IRS argued that the assets contributed to the FLP should be included in the decedent’s estate without discount under IRC Section 2036.  IRC Section 2036(a) requires estates include assets wherein the decedent retained “the possession or enjoyment of, or the right to the income from, the property”.  An exception exists to 2036 for the case of a bona fide sale for adequate and full consideration or money’s worth.  The Estate countered that the bona fide exception applies and no estate tax was due.

The Court agreed with the Estate on all counts.  First, the Court stated that the partnership was formed for legitimate non-tax reasons, meeting the bona fide sale exception.  Further, the Court found the full and adequate consideration portion was satisfied because the partnership’s books properly created and maintained each partner’s capital account and distributions were properly distributed to partners.  Since the Court found the bona fide sale for full and adequate consideration exception was satisfied, the fair market value of the assets contributed to the partnership were not included in the decedent’s gross estate. 

Every step in the process from formation until after a person’s death is critical when creating an FLP.  Where a legitimate business purpose or the proper documentation and management are lacking, problems with the IRS may arise under 2036.  Where, as in the Estate of Shurtz, all steps are thoughtfully navigated, the ability to avoid and successfully defend an IRS challenge increase exponentially. 

If you would like to discuss your FLP and how to best manage its affairs, please contact us.

If you have any questions about this law or how it affects your estate plan, please give us a call.

To recap the issue, as most Wills are currently drafted, a formula is used to maximize the federal estate tax allowance that is in existence at the time of a person’s death.  If a married individual dies in 2010, his entire estate would pour over to the Credit Shelter Trust under his will, leaving no assets to fund the Marital Trust which is necessary to maximize the spousal step up in basis).

If you are unsure of how your Will works or have questions about the funding of trusts under your Will, please give us a call.

As a result of this new carryover basis rule, there could be an issue with capturing the basis increase in $3,000,000 of assets passing to spouse under a Will.  In order to qualify for the step up in basis on the $3,000,000, the property must be held in what is known as a qualified terminable interest property trust.  As most Wills are currently drafted, a formula is used to maximize the federal estate tax allowance that is in existence at the time of a persons death.  While no one anticipated that Congress would actually allow a total repeal of the federal estate tax law, we are currently faced with that issue.  There is talk that if Congress reinstates the federal estate tax they will make it retroactive back to January 1, 2010.  However, some may challenge this as unconstitutional and we do not know if they would be successful.

Therefore, we want to inform everyone that under the current law, if a formula is used in your Will to maximize the funding of the Credit Shelter Trust, all of your assets will go to that under your Will.  What this means is that your surviving spouse may lose the right to get a step up in basis on $3,000,000 worth of assets as no assets from your estate will go to the QTIP Marital Trust.  Some argue that your family could go to court and argue that your intent was not to have all assets pass to the Credit Shelter Trust and that the court may “revise” the Will to accomplish your intent to fully maximize all benefits affordable to your spouse.  Unfortunately, we cannot advise whether this argument would be successful.

Of course, if the federal estate tax is reinstated and made retroactive, there is no issue.  However, if it is not retroactive, and if you pass away during a “total repeal” period (2010), your spouse and family may lose out on the benefits of a step up in tax basis.

Therefore, it is advisable that you contact an attorney to execute a Codicil to your Will to assure assets that pass to your spouse will be allowed to fully utilize the step up in basis rule.

There could be an issue with providing assets for some spouses under a Will, particularly if it is a second marriage.  Typically, a Will is drafted utilizing a formula to maximize the federal estate tax allowance that is in existence at the time of your death.  While no one in the legal and accounting communities anticipated that Congress would actually allow 2010 to arrive with a total repeal of the federal estate tax law, we are currently faced with that issue.  There is talk that if Congress reinstates the federal estate tax they will make it retroactive back to January 1, 2010.  However, some may challenge this as unconstitutional, and we do not know if they would be successful.

Therefore, under the current law, if the typical formula is used in your Will to maximize federal estate tax allowances, all of your assets will go to the Family Trust, also known as the Credit Shelter Trust.  What this means is that if your spouse is not named as a beneficiary under the Family Trust, they will not get any benefit from your estate as the Marital Trust created for the benefit of the spouse will not receive any assets from your estate.

In some instances in second marriages, a person’s Will provides for spouse under a Marital Trust and for children from a previous marriage under the Family Trust.  Therefore, under the current tax law this is detrimental to the surviving spouse, as all assets will go to the children from the previous marriage.  If this is not your intent, it is advisable that you contact an attorney to execute a short Codicil to your Will to assure assets will pass to a spouse in a second marriage.

Of course, if the federal estate tax is reinstated and made retroactive, there is no issue.  However, if it is not retroactive, if you pass away during a “total repeal” period (2010), your spouse will lose out on the benefits of your estate.