Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 1997

Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 1997

Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 2009

Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 1997

Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 2026

Another Way to Reach the Family Business Owner

Planned Giving Today

Originally Published in Planned Giving Today.


Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 1997

Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 1997

Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 2009

Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 1997

Warning: Illegal string offset 'status_txt' in /home/treacy/public_html/wp-content/plugins/share-and-follow/share-and-follow.php on line 2026

A potentially significant, if little-known, opportunity for charities was created by the complicated valuation rules applicable to family limited partnerships and corporations, and (indirectly) limited liability companies (“LLCs”), under Internal Revenue Code Section 2704, adopted in 1990. This may well turn out to be a good example of an opportunity for the charity to solve a nasty problem for the donor which arises under these Byzantine statutory rules.

Congress and the IRS had by the mid-1980s become increasingly alarmed by the widespread use among wealthy families of planning devices, called “estate freeze” techniques, which were designed to reduce the value of family assets for lifetime and testamentary gifts. Most relevant for our purposes was a technique which sought to reduce federal gift and estate tax on transfers of family assets by tagging on various “liquidation” restrictions to partnership interests. An interest in a family business would be worth considerably more to a “willing buyer” if this theoretical buyer could promptly liquidate his or her interest in the enterprise and pull out his or her investment.

On the other hand, a restriction on liquidation would make the interest less attractive and less valuable to such a buyer. The appraiser retained by the family could justify lower values for transfer tax purposes because of the presence of these types of restrictions, which, at least in the view of the IRS, were artificial devices which served no purpose other than tax avoidance. And you must admit, the IRS had a point there.

Section 2704

To summarize briefly, Code Section 2704 strives to have these restrictions on liquidation ignored for valuation purposes. If the parent (called the “transferor”) makes a gift of an interest in the family partnership or LLC to a child, subject to a restriction which seeks to limit the ability to liquidate (hence lowering value to a potential buyer), then the restriction is wholly ignored for valuation purposes if: (i) the parent and family members control the entity; and (ii) the restriction must either lapse after the transfer or be subject to removal by the transferor or family members, alone or collectively. (The restriction is termed an “applicable restriction” in Code Section 2704.)

That is to say, a family which owns all of the interests in a family partnership or LLC is in effect wasting its time by imposing a restriction on the ability to liquidate. No value reduction will accrue for gift and estate tax purposes, so long as it is only the family which can remove the restriction.

Giving Opportunity

This is where an interesting opportunity for a charitable gift arises. The family may be able to turn a useless restriction on liquidation into an effective value-depressant factor for gift and estate tax purposes, and avoid some of the severity of Code Section 2704, if a charity is given an interest in the family limited partnership or LLC, and if that charitable interest carries the right to prevent liquidation. The prospect of a favorite charity sharing an interest in the business will likely be attractive for the family than an “outsider” holding such an interest. The presence of a charitable (non-family) owner should prevent the liquidation restriction from constituting an ignored “applicable restriction,” so long as the charity’s interest is sufficiently large.

How large must the charity’s interest be? This will depend on applicable state law. The regulations provide that the ability to remove the liquidation restriction is to be determined with reference to the state law which would apply in the absence of a more restrictive rule in the partnership agreement or LLC instrument. In other words, if state law requires for liquidation the consent of partners holding, say 80 percent of the total partnership interests, then the charity must hold at least a 21 percent interest in order to prevent “applicable restriction” treatment.
It would seem that the “catch-all” provided in Code Section 2704(b)(4), which provides that the Treasury Department may by regulations provide that other restrictions with an effect similar to that of an “applicable restriction” can be ignored for transfer tax purposes, would not be used to prevent this technique. As usual, time (and the rulings) will tell.

Door Opener

All of this raises the question whether this is the sort of gift which a charity should seek out. The advantage to the donor, of course, is that the charitable gift of an interest in the family limited partnership or LLC may turn a useless restriction into an effective one, and thus may save gift and estate taxes. This is the sort of entrée opportunity which the charity might bring to the attention of an entrepreneur or his or her advisors, and receive a welcome rather than a closed door. In and of itself, the ownership interest may be less attractive to the charity than the opportunity afforded for garnering more substantial (and more liquid) gifts.

Of course, the charity should not accept a general partnership interest in such a transaction (not that it would likely be offered), because of the attendant liability issues involved. Rather, the interest should be a limited partnership interest, or an equivalent interest in an LLC (in which all members have limited liability, at least in theory).

IRS Circular 230 Disclosure: To the extent this message contains tax advice, the U.S. Treasury Department requires me to inform you that any such advice, whether in the body of the message or in any attachment, is not intended or written by my firm to be used, and cannot be used by any taxpayer, for the purpose of avoiding any penalties that may be imposed under the Internal Revenue Code. Advice from my firm relating to tax matters may not be used in promoting, marketing or recommending any entity, investment plan or arrangement to any taxpayer.

Publications and Articles by Topic

Business Succession Planning
Savvy Business Owners Look For Creative Plans
Charitable Planning
The Very Versatile Disclaimer: A Guide to Its Use in Charitable Planning
Charitable Trusts
De-UBIT-izing CRTs: Recent Rulings
Community Property
BNA Tax Management Portfolio – Community Property
Planning for Community Property:
A Primer for the Other 40½ States
Planning to Preserve the Advantages of Community Property
Corporate Charitable Giving
Alternative Corporate Giving Formats
Another Way to Reach the Family Business Owner
Donor Advised Funds
Cold Snap for Donor Advised Funds: The New DAF Rules
Estate Planning
Savvy Business Owners Look For Creative Plans
Guardianships
Washington Guardianship Law: Administration and Litigation, Third Edition
Patents
Surviving and Thriving In the Tax Patent Era
Private Foundations
Rulings Go Beyond ‘Plain Vanilla’ Foundations
A Taxonomy of Tax-Exempt Organizations
Probate
Probate Primer for PGOs
Public Charities
Becoming “SO-Friendly”: The Advantages of Courting Supporting Organization Relationships
A Taxonomy of Tax-Exempt Organizations
Part of the Truth About Attorneys
Accelerate Your Charity’s CRT Interest
What’s Wrong With This Gift?
The Perilous Quest for Bequests
Three Hazards for PGOs
Probate Primer for PGOs
Supporting Organizations
Hangover for Type III SOs – Treasury Issues Final Regulations for Supporting Organizations
New Regulations for Type III SOs
BNA Tax Management Portfolio – Supporting Organizations
Not SO Bad – Proposed Regulations for Type III Supporting Organizations
New ‘Guide Sheets’ on Supporting Organizations
Aftershocks: Update on Supporting Organizations
Supporting Organizations After the Pension Protection Act
So What’s Left of SOs? – The Pension Protection Act of 2006 and Its Impact on Supporting Organizations
A Wake-Up Call for “Type III” Supporting Organizations
SO Much Better?: Supporting organizations may offer the perfect balance of tax benefits and donor control for some planned giving prospects

Sign up for our newsletter!