Court Determines the Gift Tax Exclusion Applies to FLP

Author: Ron Soluri Jr.

litigation supportRecently, we discussed a case where the U.S. Tax Court held that gifts of interests in a family limited partnership (FLP) qualified for the federal annual gift tax exclusion. The decision in Estate of Wimmer v. Commissioner came as a surprise to some because, in three previous cases, the same court held that the exclusion didn’t apply to gifts of limited partnership interests.

Keeping it in the family

A married couple formed an FLP in 1996, funding it with publicly traded and dividend-paying stock. The FLP was established in part to restrict nonfamily rights to acquire family assets. The husband and wife made gifts of limited partnership interests in the FLP to various family members.

In 1996, the FLP began receiving quarterly dividends from the stock. To allow the limited partners to pay federal income tax, the FLP made distributions from 1996 through 1998. Beginning in 1999, the FLP continuously distributed all dividends — net of partnership expenses — to the partners when they were received. These were made in proportion to partnership interests. Limited partners were also given access to capital account withdrawals and they used such withdrawals for, among other things, paying portions of their residential mortgages.

After the husband died and his estate filed an estate tax return, the IRS returned a tax deficiency of $263,711. The estate asked the Tax Court to find that the gifts of limited partnership interests qualified for the annual gift tax exclusion.

Present benefits

Annual gift tax exclusions are available for “present interest gifts” only, not to gifts of future interests in property. As the court clarified, a gift in the form of a transfer of an equity interest in a business or property, such as limited partnership interests, isn’t necessarily a present interest gift.

To qualify as a present interest gift, the gift must confer on the recipient a substantial present economic benefit by reason of use, possession or enjoyment of either the property or income from the property. In this case the court decided that, because of the significant transfer restrictions in the FLP’s partnership agreement, the donees didn’t receive the rights to immediately use, possess or enjoy the limited partnership interests themselves.

3 requirements

However, the court found that the estate satisfied three requirements for income from the limited partnership interests to qualify the gifts of the interests as present interest gifts: 1) the partnership would generate income; 2) some portion of that income would flow steadily to the limited partners; and 3) that portion of income could readily be ascertained. The court concluded that the limited partners received a substantial present economic benefit.

Wimmer provides an example of the right way to administer an FLP. It’s possible to put restrictions — which often are used to create valuation discounts — on gifted limited partnership interests while still satisfying the requirements for the gifts to qualify for the annual gift tax exclusion. To ensure your clients’ FLP operating agreements walk this fine line, work with an experienced financial advisor.

If you have any questions about the gift tax exclusion or any other litigation support issue, give us a call at 716.847.2651, or you may contact us here.