A family limited partnership offers many perks, including the ability to transfer wealth at substantial discounts from the fair market value of underlying assets. But without a valuation, this perk easily could become a liability. A family limited partnership (FLP) is often regarded as a tax-advantageous vehicle for transferring wealth to future generations—one that allows you to retain control of your assets. Its most notable perk, however, may be the ability to transfer limited partner interests at substantial discounts to the partnership’s underlying assets. In recent years these discounts have captured the IRS’s attention, and, in light of controversial proposed regulations, could soon be on the chopping block. Having a valuation expert value the limited partner interests of your FLP could help to keep these discounts intact. Here are a few important things to know:
The basics of an FLP
Generally speaking, once you establish an FLP, you can contribute assets such as marketable securities, real estate, and private business interests in exchange for general and limited partner interests. Over time, you can gift, sell, or transfer these interests to family and non-family members, including charitable organizations. Because limited partnership interests do not allow for the control of day-to-day activities (lack of control) and could be difficult to sell (lack of marketability), they may be valued at a discount from the partnership’s underlying assets. To qualify for valuation discounts, the FLP must have a legitimate business purpose, such as efficient asset management and protection from creditors. FLPs set up exclusively to minimize gift and estate taxes won’t fly with the IRS.
The basics of valuing a limited partnership interest
Valuing a limited partnership interest typically starts with the partnership’s net asset value, which is the combined fair market value of its assets on a controlling, marketable basis minus any liabilities. Business valuation experts then determine if discounts for lack of control and marketability apply to the partnership interests by analyzing the assets held by the partnership, the market, and restrictions placed on the ownership interests. The applicable discounts for lack of control and marketability are separate from one another and from discounts taken at the asset level (for instance, if discounts were taken on a private business interest that was contributed to the FLP). Combined, such discounts often reduce the value of a limited partnership interests by 40 percent or more. If you haven’t properly documented and supported the discounts selected, they may not stand up to an IRS challenge. A professional valuation expert not only gives you a sound valuation of a limited partnership interest but he or she can also provide support and guidance if the IRS starts asking questions.
Considering an FLP? Talk to your attorney as soon as possible
In early December 2016, the IRS held a public hearing to discuss proposed regulations that would severely limit or remove discounts for certain family-owned business entities, including FLPs. Currently, it is unknown if the proposed regulations will be adopted, modified, or abandoned. Nevertheless, if you’re considering an FLP, now is the time to act. Talk to your attorney to get started, and look to your tax advisor or valuation expert to learn more about the potential financial consequences.
For more information go to: www.dsb-cpa.com/business-valuation
Dan Korsman (J.D., CPA/ABV) is a Value Specialist with DS+B CPAs + Business Advisors. He has extensive experience in performing valuations for financial reporting purposes (business combinations, goodwill impairment and compensation expense) and for taxation purposes. He also performs valuation and litigation services for shareholder disputes, buy-sell agreements, divorces, succession planning and calculating damages.