Blame it on Charles Reichardt. The Texas businessman, who died in 1994, stretched the bounds of a popular estate-planning vehicle too far for the Internal Revenue Service. Now family limited partnerships, which have long been a smart way for entrepreneurs to pass assets to the next generation while avoiding a chunk of the estate tax, are routinely drawing scrutiny from the IRS. Too many of the partnerships, which are known as FLPs, contain assets that are not business-related, including vacation homes, personal stock, and even cash.
That was the case with Reichardt's FLP. After the IRS successfully sued his estate, it managed to get several others nullified too. Now a case in the federal tax court could complicate the matter more if, as some observers predict, it further circumscribes the activities of a person who sets up an FLP.
FLPs didn't always have a bad reputation. They were created during the 1970s so that farmers and ranchers could pass on their businesses without their heirs going broke on property or land taxes. The FLP allows a business owner to gift assets to an heir without giving up actual control of them. When the entrepreneur dies, the FLP is dissolved, and the assets are distributed. An FLP's advantages include shielding assets from creditors or lawsuits. The biggest plus, though, is the tax benefit. A portion of assets in an FLP, usually from 17% to 55%, is untaxable.
Of course, an FLP is only necessary if an individual's estate exceeds $1.5 million. But if you want to create an FLP, "don't be greedy," says Michael Provine, a tax specialist with Traditional Capitol, in Summit, N.J. "The IRS has not been coy about what they're looking for."