Intra-family and other business transfer techniques

Free sampleEstate Planninghard

Rosa, aged 71 and widowed, forms a family limited partnership and contributes 6,000,000 dollars of quoted securities and two rental buildings. She takes a 1 percent general partner interest and gifts limited partnership interests to her three children over four years, claiming a combined discount for lack of control and lack of marketability of 32 percent on each gift. She keeps no assets outside the partnership beyond a small current account, pays her household bills and her holidays directly from the partnership bank account, and the partnership has held no meetings and pursued no activity other than holding the contributed assets. Her planner reviews the arrangement. Which assessment of the discounts is correct?

AThe discounts are at risk, because her personal use of partnership funds and the lack of a non-tax purpose can pull the undiscounted assets back into her estate Correct
BThe discounts hold, because the partnership was validly formed under state law and each gift of limited interests was properly documented and reported
CThe discounts are barred, because the special valuation rules of Internal Revenue Code Chapter 14 deny any discount on interests transferred between family members
DOnly a minority discount survives, because a discount for lack of marketability cannot be claimed where the underlying assets are freely quoted securities

Family limited partnership discounts depend on respecting the entity, so personal use of partnership assets can pull the full undiscounted value back into the estate. Two separate questions decide whether this plan works. The first is valuation: an interest carrying no control over distributions and no ready market is worth less than a pro rata slice of the underlying assets, and a combined discount in the region Rosa claimed is defensible on the right facts. The second question is whether the transfer is respected at all, and that is where these facts fail. Rosa contributed effectively everything she owned, ran her personal spending through the partnership account, and the entity did nothing but hold assets. On facts of that kind the transferor is treated as having kept the possession and enjoyment of the contributed property, so the property itself, not the discounted partnership interests, is brought into the gross estate at date of death value. The discounts then disappear entirely, and the family is worse off than if no partnership had been formed, because it has paid for the structure and gained nothing. The fix is behavioural rather than documentary: fund the partnership with less than the whole estate, keep a personal account for personal spending, hold and minute genuine meetings, respect distribution percentages, and be able to state a real non-tax reason such as consolidated management of the rental buildings.

Why A is correct: Where the transferor keeps the enjoyment of the contributed property and the entity serves no purpose beyond tax, the contributed assets can be included in the gross estate at full value, which removes the discounts rather than merely reducing them.

Why B is wrong: State law validity and clean paperwork are necessary but they are not the test; the federal estate tax question is whether Rosa kept the possession or enjoyment of the transferred property, and paying personal costs from partnership funds suggests she did.

Why C is wrong: Chapter 14 is the right body of law to have in mind and it does restrict certain retained interests and restrictive provisions, but it does not impose a blanket ban on control and marketability discounts for family entity interests.

Why D is wrong: This is a plausible sounding rule and it misplaces the valuation subject; the interest being valued is the limited partnership interest, whose transfer restrictions make it hard to sell, not the securities the partnership happens to hold.

Intra-family and other business transfer techniques

Practice question for this objective