In Technical Advice Memorandum 9751003, the IRS determined that gifts of limited partnership interests transferred to the donor's family members over a period of three years failed to qualify for the annual $10,000 gift tax exclusion provided in Section 2503(b) of the Code. In this ruling, the donor formed a limited partnership which held industrial rental property. Over a three-year period, the donor gifted limited partnership interests to 35 family members and trusts for the benefit of family members.
The IRS ruled that none of the gifted interests qualified for the annual gift tax exclusion. The IRS based its decision on l anguage in the limited partnership agreement which (i) provided for the distribution of income in the complete discretion of the general partner and allowed the general partner to retain income "for any reason whatsoever," (ii) prohibited limited partners from withdrawing from the partnership or receiving a return of capital until the year 2022, and (iii) prohibited assignment of limited partnership interests by any limited partner other than the donor. Because of these partnership agreement restrictions, the IRS determined that the gifted limited partnership interests failed to provide the recipients with substantial present economic enjoyment over the gifted partnership interests as required under Section 2503(b) for application of the annual exclusion.
This technical advice memorandum is the most recent evidence that transactions involving family limited partnerships which provide tax benefits will be closely scrutinized by the IRS. Since May 1997, the IRS has issued at least five technical advice memoranda which have attacked so-called "death bed family limited partnerships ," where assets are transferred to a family limited partnership shortly before death, limited partnership interests are transferred to family members, and discounts are claimed when determining the value of the interests transferred for estate tax purposes (see TAMs 9719006, 9723009, 9725002, 9730004 and 9735003). In all of these technical advice memoranda, the IRS disregarded the existence of the limited partnerships for estate tax valuation purposes and denied the claimed valuation discounts (see also TAM 9736004, involving a similar disregard of limited liability company restrictions). The denial of the annual exclusion in TAM 9751003 would appear to be avoidable by ensuring that the limited partnership agreement provides the limited partners with the right to enjoy present economic benefits from the partnership (e.g., by providing a mechanism for the limited partners to liquidate their interests and/or requiring that the general partner distribute net cash flow, etc.). The "default" provisions of state law may, absent other more restrictive powers in the general partner, be sufficient in and of themselves to avoid the result in the TAM.
In a related development, President Clinton's recent budget bill, issued in February of this year, seeks to end taxpayers' ability to take valuation discounts on transfers of interests in entities (such as family limited partnerships) which hold readily marketable assets. The bill proposes to eliminate valuation discounts except as they apply to active businesses. To the extent that an entity holds readily marketable assets, interests in the entity would generally be required to be valued for gift and estate tax purposes at a proportional share of the net asset value of the entity. If passed, the new law would apply to gifts made after (and decedents dying after) the date of enactment. The level of support from Congress for the President's budget bill is presently unclear, but we will closely monitor this proposal as it is considered.
