The U.S. government has increased the amount of assets from $1.5
million to $2 million you can pass to your heirs tax-free, but it
hasn't made it any easier for you to execute "deathbed transfers,"
or family limited partnerships (FLPs).
FLPs can be risky propositions for family businesses because the
Internal Revenue Service (IRS) is almost certain to initiate an
audit when one is formed. In an FLP, a parent—before
dying—transfers his assets (which can include real estate,
securities or a family business) into a partnership formed with his
children. The advantage of an FLP is that once formed, its assets
are more difficult to sell, thereby decreasing its taxable value by
as much as 40 percent. Once the parent dies, the children then can
disband the partnership and sell its assets.
Of course, the IRS sees FLPs as yet another ploy for business
owners to avoid paying significant estate taxes. In fact, in a July
2005 ruling against the FLP of Albert Strangi, his family was
forced to pay the IRS $2.6 million. Strangi had formed his FLP two
months before he died and included his house in the FLP; he
continued to live in the house rent-free for the remaining two
months of his life. In addition, during the two-month period,
Strangi took money from the FLP when he needed it for personal
expenses, defeating the idea that what he formed was an equal
To successfully form an FLP, make sure the reason is not to
avoid the estate tax. You'll have to document in writing meetings
you have had with your children to prove you intend to transfer
your business to them. In addition, don't allow any partner to
contribute to or take distributions from the FLP unless done so
according to a set schedule. Also, no partner (such as the parent)
should contribute all his wealth to the FLP; each partner should
have enough assets on which to survive without counting on
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