This past June I wrote and posted on this blog about the potential that the IRS would release new regulations on the use of Family Limited Partnerships (FLP) or Family Limited Liability Companies (FLLC) as an estate planning strategy to help shrink or eliminate a high-net worth individual’s federal estate tax burden. While the IRS had been discussing the possibility of amending its regulations to Internal Revenue Code Section 2704, it had not done so for a variety of reasons, not the least of which was Congress’ hesitancy to amend the code section in a way that would close the IRS-perceived loopholes in the law. On August 2nd, the IRS finally stopped waiting on Congress to act and released its proposed regulations on the use of FLPs and FLLCs as estate planning strategies.
The purpose of this post is not to provide specifics about the proposed regulations or explain the changes that are proposed. If you would like a more detailed explanation into the mechanics of the proposed regulations, the IRS has released a detailed explanation, which can be found here. If you prefer a private entities’ take on the matter, the Bessemer Trust has released its detailed take on the proposed regulations, which can be found here. The purpose of this article is to provide a bit of insight on when the regulations may become effective, to whom they will apply, and the major purpose behind the proposed changes.
Applicability and Effective Date
The effective date and applicability of the regulations is probably the most important issue, especially to those that may be in the process of creating and funding an FLP or those that have recently transferred assets into an FLP. The good news is that the proposed regulations will likely only apply to property transferred after the proposed regulations become effective, which can take years. However, in an apparent attempt to prevent individuals from rushing to transfer property into FLPs before the new regulations become effective, the IRS may include a “three-year rule” applied to transfers made before the effective date. This means that if an individual transfers property before the regulations become effective and dies within three years after the transfer, the new regulations will apply and the attempted discount of share valuation will be ineffective. In short, no applicability time period has been finalized and the effective date could potentially be years down the road.
Effects on Valuation Discounts
As I explained in my earlier post, the main purpose of transferring property into an FLP is so that the transferor is able to gift a minority stake of the shares at a reduced valuation due to “lack of control” and “lack of marketability” discounts. The proposed regulations main target appears to be the lack of control discounts, which can amount to a 15 to 30 percent discount under the current regulations. The new regulations have broadened the definition of what constitutes “control” to a point that the discount would be severely restricted or eliminated depending on how many shares one holds as well as operational control over the day-to-day business of the FLP.
While there are many more nuanced issues within the proposed regulations that affect a number of different planning strategies and purposes for establishing an FLP, the main purpose here is to provide notice to those that may be currently using an FLP as an estate planning strategy or those considering one. It is highly recommended to contact your attorney and financial advisor in the near future to discuss how the proposed regulations will affect your specific estate plan, your options moving forward, and ensuring you can meet you estate planning goals.
Tim practices primarily in our Wealth & Succession planning group helping clients with with estate planning and probate matters. Learn more at https://www.l-wlaw.com/attorneys/tim-b-gulbranson/.