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IsYour Family Limited Partnership Going To Get You Thrown In Jail?

By Tim Berry, JD - Email Editor

Date : June 18, 2009

Dear Valued Reader,

On June 9th, the Department of Justice announced the indictment of a number of high end attorneys. While there were a number of different charges the central theme was fraud.  

What were some of the falsehoods? Here is a smattering:

“You entered into the purchase and sale of the Options for substantial nontax business reasons, including. . .“

"You contributed the Options to the Partnership for substantial nontax business reasons, including, but not limited to, potential diversification of the risks of certain investments, the desire to co-invest as partners with the other co-partners and for your convenience."

“Your contribution of your interest in the Partnership. . . was made for substantial nontax business reasons including, but not limited to, consolidation of investment activities, bookkeeping, accounting, and tax functions and elimination of duplicate work and expenses in administration.”

In the indictment, the government states the above were false as:

“In truth and fact, the clients entered into the purchase and sale of the options in order to obtain the desired tax benefits, and had no substantial nontax business reasons for entering into them.”

“ In truth and fact, the clients had no substantial nontax business reasons for that step, and the clients took that step because the conspirators directed them to do so in order to achieve the tax losses or benefits they purchased”

“In truth and fact, the clients made the contribution in order to achieve the tax benefits and for no nontax business reason whatsoever.”

Let me emphasize this point. The government is asserting that the attorneys knew the above actions were taken for tax purposes. If in fact the attorneys knew the above actions were taken for tax purposes, the recitals stating the actions were taken for non tax purposes were lies. Thus the government is saying the attorneys engaged in fraud by putting the false statements in documents the attorneys knew, or should have known, the IRS would review. Put bluntly, the government is saying the attorneys lied to the IRS by putting nontax assertions in private documents.

How does this affect you?

Some of you may have established family limited partnerships. While a lot of you probably have some really wonderful reasons for creating those family limited partnerships, the predominant reason you finally shelled out the money to the attorney to start drafting the document was to save on estate taxes. In the eyes of the IRS, it’s pretty much a foregone conclusion that when someone establishes a limited partnership and funds it with a large amount of assets, a predominate reason for the creation and funding of the LP is to save on estate taxes.

Here's the problem, many attorneys are of the belief that an LP formed solely to save on estate taxes won’t hold water. Because of that concern and belief, the attorneys tend to put recitals into the Partnership Agreement or Operating Agreement that state the non tax reasons why the entity was created. A case in point, one article on the Internet states, “Be sure the FLP emphasizes tangible business and financial purposes rather than solely a tax advantage; it should be managed as a business.”

Similar non tax reasons frequently cited include:

• Centralized management
• Ability to pool family assets in order to have greater investment opportunities
• Impart personal business principles and investment philosophies to future generations
• Deter litigation, asset protection
• Deter a fight amongst the kids over the assets

Yes, the above are lofty goals, but what if the IRS can prove they weren’t really concerns of the creators of the partnership. What if instead the IRS asserts you knew the entity was probably going to be audited and you, and or your attorney, merely put those catch phrases in the document so as to “throw off” the IRS. Are you now liable for fraud to the IRS? After all, the rumor is close to 100% of estate tax returns are audited and so any language you put in the document will probably be reviewed by the IRS.

Just imagine this scenario: Mom, who is worth $30,000,000, is diagnosed with a terminal illness and it is estimated she has a year or two to live. The kids get along great, and there are no potential lawsuits against Mom, thus no need to protect against lawsuits and or the kids fighting over the assets.

Mom and the kids visit an estate planning attorney and learn how the use of a limited partnership could possibly give a lower value to the estate. There is no question, the overwhelming reason why the LP is created is the hope that Mom’s estate will be “devalued” to $20,000,000 thus saving the family about $5,000,000 in taxes. Then to cover their true intent, the family and estate planning attorneys put in a bunch of non tax reasons why the limited partnership was created, glossing over entirely the tax reasons for the creation.

Sure enough, Mom passes away and the family files the estate tax return claiming the value of the LP is only $20,000,000. When the IRS audits Mom’s estate tax return, they call in the kids and say, “we can do this the hard way, or we can do this the easy way. If you agree to no discount valuation we will forget we ever talked to you. If however, you insist upon asking for a discount valuation we will charge each and every one of you with tax fraud for signing the Partnership agreement saying there were
substantial nontax reasons for creating the LP.” A bit far fetched? I would love to think so.

But stop and think about the logic of the indictment mentioned above. The promoters drafted private documents with false statements in order to obtain a tax benefit.

What did your family do?

It caused a document with false statements to be drafted in order to obtain an estate tax benefit.

See the similarity?

So what is the next step, what should you do to protect yourself? First and foremost is to review your limited partnership or LLC agreements to make sure each and every statement is true, correct and can be backed up. Going even further, you might want to reconsider the use of an LP or LLC to achieve estate planning goals. At their most simplistic, LPs and LLCs are business entities, to try and make those round pegs fit in the square hole of estate planning, something is going to have to give.

Instead, if you are engaging in estate planning, use the tried and tested estate planning tool of a trust. It may not provide you with the instant benefit the LP is promoted as providing you, but at the same time you may be able to sleep a lot easier knowing you aren’t giving the government any ammunition to bring criminal charges against you.This problem as well as others we encounter when reviewing clients situations can be very easily remedied by planning for one's inheritance. In the near future we will be rolling out some education modules on "Inheritance Planning" and what you can do to maximize the amount of asset protection and tax planning on any assets you may inherit in the future.

Until next time,

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