Tax Benefits for Family Business Owners

Family limited partnerships are emerging as a favorite tax advantaged vehicle for transferring family businesses or real estate to the owners’ sons and daughters. If properly created, funded and operated, family limited partnerships can be used to achieve considerable income, estate and gift tax benefits.

Succession planning experts consider the family limited partnership a key element of any sophisticated estate plan. One reason for the popularity of these tax saving devices is because family business owners can take advantage of multiple discounts for the value of minority interests transferred to family members. The appropriate amount of a minority interest discount varies, but discounts in the 15 to 30 percent range are common.

For years, the Internal Revenue Service strenuously resisted this concept, but after several tax court defeats, recently the IRS has agreed that these discounts are legitimate. However, the IRS continues to closely scrutinize the size of discounts claimed by taxpayers. One rule is that the more facts that exist to discourage an arms-length buyer, the greater the discount.

Our first step in the family limited partnership process is to obtain a professional appraisal of the business or real estate. In addition to supporting a minority interest discount, a well-documented appraisal also may support a lack-of-marketability discount. Tax courts have allowed lack-of-marketability discounts of as much as 36 percent. This discount often is warranted because no ready market exists for the sale of an interest in a closely-held, family business. This contrasts to the established markets for the stock of larger, publicly-held corporations.

Properly structured and operated family limited partnerships also may be used to shift income from a business owner in a higher tax bracket to a family member in a lower tax bracket. The Internal Revenue Code provides that a donor may give up to $10,000 in value to each donee, in any calendar year, without the transfer constituting a taxable gift, provided that the gift is of a present interest. Married couples can aggregate their exclusions and give each child or grandchild $20,000 a year.

Clearly, gifts of family limited partnership interests are well suited for taking advantage of this annual gift exclusion.