A provision in President-elect Barack Obama's proposed estate plan would impose tighter restrictions on a popular vehicle for reducing estate and gift taxes.
Under the Obama plan, only business assets would be discounted in family limited partnerships. That means that assets that are personally owned by family members — such as stocks, bonds or real estate — would no longer be eligible for discounting.
"This bill eliminates some of the techniques that have been used extensively and will enhance government revenue," said Martin Shenkman, an estate planning attorney from an eponymous firm in Paramus, N.J. "You won't have a public outcry on clamping down on something that only the wealthiest can do."
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In a family limited partnership, family members — usually the parents — transfer assets into a partnership formed with their children and agree to give up majority interests in those assets, in exchange for estate gift discounts.
The strategy reduces the value of the taxable estate of the parents.
ABUSES FOUND
In recent years, the Internal Revenue Service has stepped up its scrutiny of family limited partnerships after finding evidence that some wealthy individuals were using the vehicle as a tax dodge. In some cases, family members were taking discounts of 60% to 70% with little or no documentation.
While acknowledging that this provision has been abused in the past, Sidney A. Blum, a certified financial planner with GreenLight Fee Only Advisors LLC of Evanston, Ill., said creating family limited partnerships and getting discounts on various assets, including stocks and bonds, is a valid estate-planning tool.
"It's taught in estate-planning courses on how to get discounts," he said. "It's used very commonly to get these discounts. But the IRS has never liked it."
Mr. Blum believes that the discounts should be allowed on any asset held in the partnership — if for no other reason than the fact that the family members are forced to give up control of that asset when the partnership is created.
Attorney Perry Granz said his Boston-based law firm, Tarlow Breed Hart & Rodgers PC, believes that these partnerships are valid, and said it's important to show documentation that the proper discounts are being taken.
"If it's done above-board and all of the formalities are followed, then why is the discount valid in a business setting but not a non-business setting?" he asked.
The two discounts available are lack-of-marketability and minority discounts. The former discount is given because under the partnership agreement, the sale or transfer of assets is prohibited. The latter discount is given because previous owners are giving up the majority ownership.
"Donors are giving something up to do this," Mr. Granz said. "You're going from a 51% owner to, let's say, a 36% owner."
All assets should be given discounts when the proper procedures have been followed, said Craig S. Richards, a senior vice president and director of tax services for New York-based Fiduciary Trust Company International, who is also a certified financial planner.
His firm manages about $10 billion in assets.
KUDOS FOR PLAN
Even though attorneys and advisers are concerned about the provision that will limit assets in family partnerships, they say Mr. Obama's estate tax plan would eliminate some of the uncertainty in estate planning that they've experienced for the past several years. In Mr. Obama's plan, the estate tax exemption will be $3.5 million for individuals and $7 million for couples.
Currently, the estate tax exemption is scheduled to disappear next year and return in 2011 at $1 million.
"Without a doubt, it makes it easier to know what it is," said Diane Pearson, a financial adviser at Legend Financial Advisors Inc. in Pittsburgh. The firm manages about $360 million in assets.
"We had to draft very flexible documents. We've all been sitting on the sidelines and waiting to see what will happen," Ms. Pearson said.
It will be easier to help clients plan since Mr. Obama has signaled that the estate tax won't be going away, said Penny Marlin, a sole proprietor who manages about $20 million in assets in Delray Beach, Fla.
"I don't think anyone thought the estate tax was going away," she said. "The $3.5 million exemption for a married couple is really a $7 million exemption, and that's pretty substantial."
E-mail Lisa Shidler at lshidler@investmentnews.com.
