Certain Estate Tax Relief Act of 2009
Louis A. (Drew) LaGrande, Esq. is a contributing author to the Yesner & Boss, P.L. blog and the following is a recent article which he contributed. Drew is a partner at Akerman Senterfitt based in Tampa, FL and specializes in legal areas such as estate planning and taxation.
House Resolution 436 (H.R. 436) was introduced by Representative Earl Pomeroy on January 9, 2009, in the House of Representatives. This bill is entitled "Certain Estate Tax Relief Act of 2009" (the "2009 Act"). The 2009 Act was introduced to "amend the Internal Revenue Code of 1986 to repeal the new carryover basis rules in order to prevent tax increases and the imposition of compliant burdens on many more estates than would benefit from repeal, to retain the estate tax with a $3.5 million exemption and for other purposes."
The phrase "for other purposes" tends to grab one's attention! In referencing "for other purposes", the 2009 Act seems to restrict the valuation in minority discounts which are commonly used to discount the value of the family limited partnerships. The proposed 2009 Act seems to be trying to eliminate or drastically reduce the use of these entities which are commonly used to obtain discounts for lack of marketability and lack of control for IRS purposes. These discounts do not reduce the underlying value of the property held by such entities.
The 2009 Act eliminates the carryover basis rules that were to become effective in 2010. Currently, if an individual passes away, such individual's assets will receive a stepped-up basis of the assets upon such deceased individual's date of death. In other words, if a decedent purchased an asset with a value of $10.00 and passed away with the value of such asset being $100.00, then the decedent's beneficiary would receive the property with a value of $100.00. If the basis provisions are not repealed, the beneficiaries of the decedent's assets would not receive a stepped-up basis and would be responsible for determining the basis of the asset at the time the decedent purchased such asset. Not only will the beneficiaries have to determine the basis of such asset, they will also receive the asset valued at $100.00 with a basis of $10.00. If the beneficiary sells this asset, obviously there will be $90.00 in gain ($100.00 - $10.00).
The 2009 Act also freezes the applicable exclusion amount at $3.5 million. The applicable exclusion is the amount that can pass free of estate tax to any individual. In addition, the maximum estate tax rates would be kept at 45%.
The "other" portion of the 2009 Act provides certain valuation rules for certain transfers of non-business assets. The 2009 Act indicates, in general, that the value of any non-business assets held in any entity shall be determined as if the transferor had transferred such assets directly to the transferee and that the non-business assets shall be taken into account in determining the value of the interest in the entity. The 2009 Act goes on to define "non-business assets" and "passive assets."
Assets commonly transferred to family limited partnerships include cash, stocks and bonds, profits with capital interests in other entities, notes, mortgages, real property, and intellectual property. These assets would be deemed "passive" and, therefore, not considered to be used in the act of conducting a trade or business. If this bill is passed in its current form, no valuation discount will be allowed with respect to such non-business assets.
This 2009 Act also removes the ability to discount the value of a family limited partnership based upon the assets it owns and/or the business it conducts.
One way many practitioners reduce client's estate tax liability is to recommend the use of a family limited partnership. If structured properly, the use of a family limited partnership could reduce the value of a decedent's gross estate and, ultimately, the decedent's estate tax liability. Generally, the family member creates a family limited partnership and, directly or indirectly, gives up control of such assets transferred to the family limited partnership. Since the owner of a partnership cannot readily sell the assets on any current market and such individual lacks the ability to control the entity, the IRS will generally allow discounts on the value of the partnership interest for the lack of marketability and lack of control.
Obviously, a willing buyer would not pay full price for a family limited partnership interest if such buyer could not control the assets in the partnership. Therefore, the partnership's value for IRS purposes should be reduced. Likewise, since the owner of the partnership interest cannot readily sell the limited partnership interest on any available market, the value of such partnership interest may be reduced.
The 2009 Act will effectively eliminate the discounts for minority interests as well as discounts for a lack of control. By limiting these discounts, the 2009 Act will handicap the use of family limited partnerships as a vehicle to discount and reduce the decedent's potential estate tax liability.
However, under many state laws, the effectiveness of a family limited partnership will remain intact as a vehicle for wealth preservation. The family limited partnership can serve as a wealth preservation vehicle to insure that such individual's assets owned by the family limited partnership are protected from a forced sale by a creditor. In Florida, a creditor's only remedy is a charging order. A charging order indicates that if there is ever a distribution from the partnership, the creditor will be able to access such distribution. However, the creditor will not be able to become a partner of the partnership nor will it be able to "pierce the corporate veil" to take control of the family limited partnership. Therefore, if the family limited partnership was respected as a separate entity and there is no indication of fraud, the creditor may not be able to judiciously foreclose any interest of the partners and may only be entitled to a charging order. If a charging order is obtained against a partnership, the partners can withhold distributions and force the creditor to settle any claims.
The partnership also possesses additional advantages other than the discountability of the value for IRS purposes. These advantages include:
The 2009 Act eliminates the carryover basis rules that were to become effective in 2010. Currently, if an individual passes away, such individual's assets will receive a stepped-up basis of the assets upon such deceased individual's date of death. In other words, if a decedent purchased an asset with a value of $10.00 and passed away with the value of such asset being $100.00, then the decedent's beneficiary would receive the property with a value of $100.00. If the basis provisions are not repealed, the beneficiaries of the decedent's assets would not receive a stepped-up basis and would be responsible for determining the basis of the asset at the time the decedent purchased such asset. Not only will the beneficiaries have to determine the basis of such asset, they will also receive the asset valued at $100.00 with a basis of $10.00. If the beneficiary sells this asset, obviously there will be $90.00 in gain ($100.00 - $10.00).
The 2009 Act also freezes the applicable exclusion amount at $3.5 million. The applicable exclusion is the amount that can pass free of estate tax to any individual. In addition, the maximum estate tax rates would be kept at 45%.
The "other" portion of the 2009 Act provides certain valuation rules for certain transfers of non-business assets. The 2009 Act indicates, in general, that the value of any non-business assets held in any entity shall be determined as if the transferor had transferred such assets directly to the transferee and that the non-business assets shall be taken into account in determining the value of the interest in the entity. The 2009 Act goes on to define "non-business assets" and "passive assets."
Assets commonly transferred to family limited partnerships include cash, stocks and bonds, profits with capital interests in other entities, notes, mortgages, real property, and intellectual property. These assets would be deemed "passive" and, therefore, not considered to be used in the act of conducting a trade or business. If this bill is passed in its current form, no valuation discount will be allowed with respect to such non-business assets.
This 2009 Act also removes the ability to discount the value of a family limited partnership based upon the assets it owns and/or the business it conducts.
One way many practitioners reduce client's estate tax liability is to recommend the use of a family limited partnership. If structured properly, the use of a family limited partnership could reduce the value of a decedent's gross estate and, ultimately, the decedent's estate tax liability. Generally, the family member creates a family limited partnership and, directly or indirectly, gives up control of such assets transferred to the family limited partnership. Since the owner of a partnership cannot readily sell the assets on any current market and such individual lacks the ability to control the entity, the IRS will generally allow discounts on the value of the partnership interest for the lack of marketability and lack of control.
Obviously, a willing buyer would not pay full price for a family limited partnership interest if such buyer could not control the assets in the partnership. Therefore, the partnership's value for IRS purposes should be reduced. Likewise, since the owner of the partnership interest cannot readily sell the limited partnership interest on any available market, the value of such partnership interest may be reduced.
The 2009 Act will effectively eliminate the discounts for minority interests as well as discounts for a lack of control. By limiting these discounts, the 2009 Act will handicap the use of family limited partnerships as a vehicle to discount and reduce the decedent's potential estate tax liability.
However, under many state laws, the effectiveness of a family limited partnership will remain intact as a vehicle for wealth preservation. The family limited partnership can serve as a wealth preservation vehicle to insure that such individual's assets owned by the family limited partnership are protected from a forced sale by a creditor. In Florida, a creditor's only remedy is a charging order. A charging order indicates that if there is ever a distribution from the partnership, the creditor will be able to access such distribution. However, the creditor will not be able to become a partner of the partnership nor will it be able to "pierce the corporate veil" to take control of the family limited partnership. Therefore, if the family limited partnership was respected as a separate entity and there is no indication of fraud, the creditor may not be able to judiciously foreclose any interest of the partners and may only be entitled to a charging order. If a charging order is obtained against a partnership, the partners can withhold distributions and force the creditor to settle any claims.
The partnership also possesses additional advantages other than the discountability of the value for IRS purposes. These advantages include:
- Consolidation of assets for ease of management of such assets.
- Provides limited liability through wealth preservation which is not available through individual ownership.
- Provides ease of additional estate planning for the purpose of giving or selling limited partnership interests to children and/or grandchildren or creating trusts for children and/or grandchildren.
Although the use of a family limited partnership may be significantly hindered by the 2009 Act, if passed in its present form, there are still viable uses in certain situations for a family limited partnership.