What are the tax benefits provided by a Limited Partnership?
A Limited Partnership provides significant opportunities to reduce your estate taxes. In fact, many partnerships are created principally because the partners receive significant accounting discounts in the value of property transferred to the partnership.
The greater the discounted value of the property transferred to the partnership, the lower its taxable value for gift and estate tax purposes.
The ability to discount an asset’s value when transferred to a Limited Partnership is a result of how assets are valued on the free market. The Internal Revenue Service and Tax Courts recognize that the fair market value of an asset over which you possess total control is greater than the fair market value of an asset over which you possess little control. No one would pay the same price for a business controlled by others (even family members), as they would pay for a business they could run as they pleased.
A Limited Partnership may be an attractive estate planning tool because, due to the limited partner’s lack of control over the management of partnership assets, a legitimate discount in the asset’s free market value will be available for their interest in the partnership.
Generally speaking, the less control a limited partner has in the partnership, the greater the valuation discount given. In order to obtain the maximum discount, many partnership agreements intentionally contain many restrictions on the rights of limited partners to be involved in partnership decisions, to withdraw from the partnership, and even on their right to sell their partnership interests. Such partnership restrictions must not be more severe than those permitted by state law or they will be disregarded for the calculation of any discount.
Limited Partnerships can also be coupled with gifting strategies to help you reduce estate taxes. To accomplish this, you would first create a Limited Partnership and transfer assets (such as a family business) to it. Then over a period of years you would slowly transfer partnership interests to your children who are made limited partners. The value of the partnership interests transferred is intentionally kept below the annual gift tax exemption amount to avoid any gift tax liability. When done correctly, this strategy can transfer a significant part of the estate to the children gift and estate tax-free while keeping the parents in total control.
A Limited Partnership can also be used by families to provide income tax savings to family members. Subject to certain restrictions, the members of a Limited Partnership can allocate income and deductions among the general and limited partners in any agreed upon way. This ability to allocate income to individual partners permits a family to distribute partnership income to lower tax bracket members.