Farming families often are challenged with the issue of fair and equitable distribution of their major asset: farm land. The importance of your land is crucial in a variety of levels. For one, it is a crucial component of your farming operation. Second, it is something that you will have when you are ready to retire to use as an income stream. Third, it is something that can create a considerable estate tax liability, based on the value and its likelihood to increase in value. Also, it is crucial that it stays intact as a part of your farming operation for the next farming generation. There are some options that address those various issues. One option that has been used by farming families in estate planning is an entity known as a Family Limited Liability Limited Partnership. (“FLLLP.”)
A FLLLP is an entity with two classes of partners:
1) General Partners
Ø Unlimited liability
Ø Management / Control in the partnership
Ø The general partners have pretty much complete control over the management of the partnership and its assets.
Ø Often, families set up a separate entity (LLC) to be the General Partner, to attain additional asset protection – dealing with the unlimited liability issue.
2) Limited Partners
Ø Limited liability
Ø Zero control in the partnership
Ø The limited partners are basically passive investors who have no say over the day-to-day management of the affairs of the partnership.
Generally, the two classes of partners are set up as follows: The original owners of the land (“mom and dad”) set up the FLLLP and transfer their land into the entity, so that they each own an equal share of the FLLLP. They would own their shares of the FLLLP as the general partners and also the limited partners. Mom and dad (or the LLC they set up 50/50) would own a nominal general partnership interest (usually 1 % each.)
Additionally, mom and dad own the limited partnership interests of 98% (49% each).
Once this has occurred, the estate tax liability component of this tool has begun. The benefit of this entity is that you are able to use Minority and Marketability discounts to reduce the value of the assets held within the entity. Because the limited partnership interest in the FLLLP lacks control (minority interest) and lacks free transferability (marketability), a discount can be obtained for the limited partnership with a qualified appraisal. What does this mean? If one or both of the owners pass away, the value of the FLLLP shares would be valued less than the value of the land If it was owned outside of the FLLLP in your individual names. The less the value of the asset leads to less the estate tax liability.
The question with minority and marketability discounts is “how much” of a discount is allowed? It is my understanding that there is no set amount that is allowed; instead, it is an area that is set by the court system. Basically, owners of a FLLLP take a discount as described above which they feel is reasonable. If the IRS challenges it, the matter is then taken to court, and the court determines whether the discount taken is reasonable. If this is a tool you are looking to use, it is crucial to talk with your professionals about thee discount. A reasonable discount will ultimately be determined by your CPA and attorney, should you decide to go in this direction.
If a FLLLP is created, there are necessary responsibilities to complete, in order to ensure that the strategy works as you intended. There is the requirement of keeping a separate set of records, check book, and the importance of drafting and updating the governing documents associated with the FLLLP. Specifically, at a minimum, a partnership agreement would need to be drafted that would lay out the operational rules of the partnership.
Additionally, at a minimum, a buy-sell agreement would have to be drafted to address what happens in the event of death, disability, or dissolution of the entity. Finally, it is crucial that the partners of the partnership have at least annual meetings, and that those meetings are properly documented using minutes. The entity and the governing documents would be completed by your attorney, should you and he decide this is the route you want to take.
The potential downsides of a FLLLP are the above referenced requirement of a separate set of books, tax returns and records. Moreover, the above referenced minority and marketability discounts could be disallowed in the future. If this occurred, then the main reason for using a FLLLP would no longer be available.
My next posts will discuss some further options with FLLLPs, exploring their uses more with regards to estate planning. It will discuss how it can keep the farm land "intact" for the family farmers, and also allow for a fair and equitable distribution of assets.
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Required Disclosure Pursuant to IRS Circular 230: Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code; or (2) promoting, marketing or recommending to another party any transaction or matter addressed in this communication.