Rachuba Law Offices, P.C
Amend Your FLP’s and FLLCs for Fisher/Price
Many of our clients have created family limited partnerships (“FLPs”) and Family Limited Liability Companies (“FLLCs”) for a variety of business reasons. Often, they will gift interests in those entities to children, grandchildren, or trusts set up for their descendants. If they want to avoid using their lifetime gift exemption (currently $1 million dollars) or if they have no lifetime gift exemption remaining, they will gift an amount equal to the annual gift tax exclusion for that year (currently $13,000 per donee). For example, a mother and father could gift $26,000 worth of limited partnership interest to each of their children without using any of their lifetime gift tax exemption.
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.