Family Limited Partnerships and Limited Liability Companies (Portfolio 812)

Tax Management Portfolio, Family Limited Partnerships and Limited Liability Companies, No. 812-3rd, discusses income and transfer tax considerations and nontax considerations relating to the formation, operation and termination of family limited partnerships and limited liability companies (LLCs). 

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Tax Management Portfolio, Family Limited Partnerships and Limited Liability Companies, No. 812-3rd, discusses income and transfer tax considerations and nontax considerations relating to the formation, operation and termination of family limited partnerships and limited liability companies (LLCs). The portfolio includes a general discussion of the goals of family members in establishing limited partnerships and LLCs, the various techniques available for reducing or eliminating transfer taxes, and the income tax rules pertaining to the recognition of an entity as a partnership for federal income tax purposes.
The portfolio explores valuation issues, including the various discounts or premiums that may apply to transfers of interests in limited partnerships and LLCs. It discusses the validity of a partnership or LLC formed for the purpose of holding marketable securities and the Internal Revenue Service's challenges to valuation discounts. The portfolio also covers the special valuation rules under Chapter 14 as they apply to family limited partnerships and LLCs. The portfolio discusses the availability of the annual exclusion for transfers of interests in family limited partnerships and LLCs and the potential inclusion of transferred interests in the transferor's estate.
The portfolio examines the issues involved in choosing the appropriate entity for holding family assets, including marketable securities, real estate, and operating businesses. It contains a detailed discussion of the desired characteristics of the family business entity. The portfolio covers issues involved in forming and liquidating the entity, including the potential application of the anti-abuse regulation under the partnership rules, tax-free formation treatment, and classification of the entity for federal tax purposes. The portfolio contains a discussion of the issues that should be considered when drafting the limited partnership agreement or operating agreement. Finally, the portfolio discusses business and other nontax reasons for a family to use a limited partnership or LLC to hold family investments and operating businesses.
This portfolio may be cited as Mezzullo, 812-3rd T.M., Family Limited Partnerships and Limited Liability Companies.

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Louis A. Mezzullo, University of Maryland (B.A. 1967, M.A. 1976), University of Richmond (J.D. 1976); Partner, Luce, Forward, Hamilton & Scripps LLP (2006–present); Partner, McGuireWoods LLP, Richmond, Virginia (2003–2006); Member, Mezzullo & Guare, PLC, Richmond, Virginia (2000–2003); Founding Member, Mezzullo & McCandlish, Richmond, Virginia (1982–2000); Adjunct Professor, University of Miami School of Law (2004–2007); University of Richmond Law School (1978–2006); Author, 803 T.M., The Mobile Client: Tax, Community Property, and Other Considerations; 809 T.M., Estate Planning for Owners of Closely Held Business Interests; 378/814 T.M., Estate and Gift Tax Issues for Employee Benefit Plans; 831 T.M., Valuation of Corporate Stock; 835 T.M., Transfers of Interests in Family Entities Under Chapter 14: Sections 2701, 2703, and 2704; Author, An Estate Planner's Guide to Buy-Sell Agreements; An Estate Planner's Guide to Life Insurance; An Estate Planner's Guide to Qualified Retirement Plan Benefits; An Estate Planner's Guide to Family Business Entities; and Valuation Rules Under Chapter 14, all published by the American Bar Association, and Limited Liability Companies in Virginia, published by the Virginia Law Foundation; Co-author, Advising the Elderly Client, published by Clark, Boardman, Callaghan; Fellow and Past Chair, American College of Tax Counsel; Fellow and Secretary, American College of Trust and Estate Counsel; Charter Fellow, American College of Employee Benefits Counsel; Past Chair, ABA Section of Real Property, Trust and Estate Law (2000–2001); Vice-Chair of Publications and Current Chair of the Business Planning Subcommittee of the Estate and Gift Taxes Committee of the ABA Section of Taxation; and Academician and Vice President, International Academy of Trust and Estate Law.


Detailed Analysis

I. Introduction

A. Goals

B. Techniques

1. Trusts

2. Business Entities

C. Reducing Transfer Taxes

1. Lifetime Giving

2. Discounts and Premiums

II. Recognition of Family Partnerships and LLCs for Income Tax Purposes

A. Introduction

1. Case Law and IRS Position Before § 704(e)

2. Congressional Response to Culbertson

B. Regulations Under § 704(e)

1. In General

a. Donee Partner

b. Real Ownership

c. Capital as a Material Income-Producing Factor

d. Capital Interest

e. Motive

2. Basic Tests as to Ownership

a. General Principles

b. Relevant Factors

(1) Retained Controls

(2) Indirect Controls

(3) Participation in Management

(4) Income Distributions

(5) Conduct of the Partnership's Business

c. Trustee as a Partner

d. Minor Child as a Partner

e. Limited Partners

3. Allocation of Family Partnership Income

4. Purchased Interest

III. Valuation Issues: In General

A. Introduction

B. Lack of Control Discount

C. Lack of Marketability Discount

D. Premiums

E. Going Concern Value v. Liquidation Value

F. Valuing Interests Held in Specific Entities

1. Corporations

2. Limited Partnerships

3. LLCs

G. Business Appraisals

H. Marketable Securities

I. The IRS's Challenge

1. The TAMs

2. Schauerhamer and Later Decisions- The § 2036(a) Approach

3. More Recent Cases

4. IRS Appeals Settlement Guidelines

IV. Special Valuation Rules

A. Introduction

B. Transfers of Partnership and LLC Interests

C. Transfers of Interests in Trusts

D. Rights or Restrictions

E. Lapsing Voting and Liquidation Rights

F. Applicable Restrictions

V. Other Transfer Tax Issues

A. Annual Exclusion

B. Retained Interests or Powers

C. Section 2036(b)

D. Additional Transfer Tax Issues

1. Gift on Formation

2. Marital Deduction

3. Section 2035 Transfers

VI. Choice of Entity

A. Introduction

1. Significance of Issue

2. Tax Issues

3. Nontax Issues

4. State Law

5. Types of Entities

6. Disregarded Entities

B. Desirable Characteristics

1. Nontax Characteristics

a. Limited Liability

b. Retention of Control

c. Continuity of Life

d. Restrictions on Transferability

e. One Business Entity

f. Restrictions on Voting and Management Rights

g. Protecting Assets from Exposure to Liability

h. Protecting Assets from Creditors of the Owner

i. Simple and Inexpensive

j. Dealing with Recalcitrant Family Members

2. Tax Characteristics

a. Partnership Tax Treatment

b. No Restrictions on Ownership

c. No Restrictions on Capital Structure

d. Tax-Free Formation

e. Tax-Free Contributions

f. Tax-Free Withdrawals

g. Adjustment to Basis

h. Discounts and Premiums

i. Self-Employment Tax

VII. Formation and Liquidation Issues

A. Introduction

B. Anti-Abuse Regulation

C. Tax-Free Formation

D. Classification

E. Avoiding an Indirect Gift When Funding the Business Entity.

F. Liquidation Issues

1. In General

2. The Gain Provisions

a. Built-In Gain

b. Marketable Securities Treated as Money

c. Precontribution Gain

3. Disproportionate Distributions

4. Avoiding Gain on Distributions

VIII. Drafting Issues

A. Introduction

B. Important Provisions in the Operative Agreement

1. Business Purpose

2. The Economic Arrangement Among the Partners or Members

3. The Management Structure

4. Dissolution and Liquidation

C. Classification for Income Tax Purposes

D. Self-Employment Income

E. Estate Planning Issues

1. Special Valuation Rules

2. Gift and Estate Tax Issues

F. Other Tax Considerations

1. Cash Method of Accounting

2. Special Allocations

3. Contributions of Appreciated Property

4. Family Partnership Rules

5. Constructive Termination of the Entity

6. Basis Adjustments

7. Tax Matters Partner

8. Passive Loss Rules

IX. Business and Other Nontax Reasons for Using Limited Partnerships and LLCs

A. Introduction

B. Retaining Control over the Business

C. Reduced Expenses

D. Protection from Creditors

1. Protection of the Owners

2. Protection of Entity's Assets from Owners' Creditors

E. Investment Policies

F. Dealing with Disputes


Working Papers

Table of Worksheets


Worksheet 1 Example of Tax Savings Using Real Estate in an LLC

Worksheet 2 Example of Tax Savings Using Marketable Securities in an LLC

Worksheet 3 Sample Limited Partnership Agreement

Worksheet 4 Sample Certificate of Limited Partnership

Worksheet 5 Sample Deed of Gift for Limited Partnership Interest

Worksheet 6 Sample Letter to Client Explaining Provisions of Limited Partnership Agreement

Worksheet 7 Sample LLC Operating Agreement (Manager-Managed)

Worksheet 8 Sample LLC Articles of Organization

Worksheet 9 Sample Consent of LLC Organizer

Worksheet 10 Sample Deed of Gift for LLC Interest

Worksheet 11 Sample Letter and Memorandum to Client Explaining Provisions of LLC Operating Agreement

Worksheet 12 Appeals Coordinated Issue Settlement Guidelines





Treasury Rulings:

Public Laws and Committee Reports:

Federal Cases:

State Cases: