For a number of years the IRS has attacked FLPs and FLLCs on the basis that there is no valid business purpose for the entity. Clients and their advisors have argued that a key reason for using the LP form is so that capital can be concentrated or pooled and then invested for greater resulting returns. Credible evidence is cited to support the contention that money invested with a long term investment timeline, and with a disciplined investment policy, will yield greater returns than money invested in response to demands for quarterly or annual performance. The problem has been that in many of the reported cases, as well as in our experience, many senior family members contribute assets to their LPs with the idea that they like the way they are currently invested and see no reason to make a change. While this is clearly a choice, it is important for our clients to know that the courts have repeatedly cited this lack of change in investment strategy as evidence that the creation of the LP was "only a change of title" or resulted in a "mere recycling of value." The courts have said that this was strong evidence that the LP was not formed to accomplish true business and investment purposes. The lack of a true business or investment purpose leaves the courts with the inference that the LP was formed solely for tax avoidance and should therefore be ignored. Best practice: After assets are transferred to the LP, work with the partnership to create an investment policy statement (IPS) that outlines how the LP intends to invest, why it intends to invest in a certain way, and what results are expected to be achieved. The LP should then implement the investment policy as soon as possible. Understand that not all assets need to be sold and reinvested immediately. Stock with built-in gains or restrictions will need to have a slower exit in order to avoid or postpone capital gains taxes, or to comply with SEC rules. The solution in such cases will be to spell out the problem and the course of action the partnership intends to pursue to escape from the problem. The more the LP can distinguish its new investment strategy from senior family members' prior strategy, the better it will stand against possible attack. Remind clients that in many cases, a change in investment strategy will also make sense for reasons other than LP compliance with the requirement for a valid business purpose. Most partners in family partnerships or LLCs are children and grandchildren, or trusts created for them. Because their life expectancies are longer than that of the senior family members, they are likely to have a longer investing time horizon. As such, the younger generation partners have a greater ability to invest for the long term and to withstand market downturns and volatility. By recommending that your clients treat the LP as a real business investing vehicle, you will be helping your clients to achieve their wealth transfer and wealth preservation objectives. Some cases where the courts have specifically called the tax payers to task for "merely recycling of value" include: ·         Estate of Harper v. Commissioner, T.C. Memo 2002-121 (U.S. Tax Court 2002). ·         Estate of Bigelow 89 T.C. M. 954 (2005). ·         Estate of Strangi v. Commissioner, 85 T.C. Memo 1331 (2003) ·         Estate of Concetta H. Rector v. Comm., T.C. Memo 2007-367

Scott Hamilton, CEO, InKnowVision, LLC

www.InKnowVision.com

scott@inknowvision.com

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