Much has been written about the so-called "Discount Family Limited Partnership." The April, 1999 Lane Report describes how it can tax-efficiently shift taxable income among family members, save estate taxes, and shield assets from the claims of creditors.
The truth is that, as attractive a strategy as the Discount Family Limited Partnership can be, it's not for everyone: it requires the client to part with wealth which he or she may not yet be prepared to do; it can be tricky to design; and it is not entirely without tax risks, especially since it depends on gifting assets and claiming discounts for gift tax purposes which may be challenged by the IRS.
Sometimes less is more.
For many people the very same benefits can be achieved cheaper, easier and with less risk by using a simple limited partnership structure coupled with targeted guarantees of bank debt by wealthy family members.
The client sets up a plain-old limited partnership and installs himself as a 1% "general partner," the guy who calls the shots. The other 99% is owned by a trust that benefits the younger generation; it's funded by a cash gift small enough to avoid any tax issues, perhaps just $5,000, and obviously involving no valuation or discounting issues. Both the client and the trust he's funded then contribute nominal sums to the partnership for their respective ownership interests.
Whenever the partnership decides to pursue an investment, it borrows the money it needs from a bank. The loan is guaranteed by the client, and as long as its terms are met, nobody owes any gift tax. Assuming the client happens to have funds on deposit at the bank, the interest rate on the loan might be only 2% more than the interest rate the client earns on those funds. Once the partnership builds its own wealth by profiting from its investments, even that cost will become avoidable.
The result can be a "win-win." The client will not have transferred any of his wealth. The returns on investment after any bank interest will almost entirely accrue to the younger generation. No gift or estate taxes will have been triggered. And the cost of appraisals and the uncertainty associated with aggressive tax reporting positions will never come into play. Yet, wealth will have effectively been shifted to the younger generation.
Discount Family Limited Partnerships have their place. Where they fit, they may be irresistible. Where they don't, alternative approaches such as this one, as simple as it sounds, may make perfect sense. Of course, the analysis can be a complex one, and legal counsel should be brought into the decision-making early on.
The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright, 2003 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.