Use of a Family Limited Partnership for Post-Death Transfers Can Cause Problems

When an estate is large enough to encounter the federal estate tax (very few are), it is critical to utilize appropriate estate planning techniques to minimize (or eliminate) the impact of the tax.  For the extremely wealthy, family limited partnerships can be an effective tool for lifetime gifting and for achieving valuation discounts on transferred interests at death.  They are particularly useful when trying to pass a family business down from one generation to the next.  But, they may not be the best vehicle to pass property interests to upon death when factoring in the state inheritance tax.  That fact was borne out by an Iowa Department of Revenue (IDOR) Letter of Finding.

The decedent’s will passed property to a family partnership.  Under the Iowa inheritance tax regime, some persons that are related to the decedent are exempt from the tax.  Others, less closely related are taxed, but at a reduced rate.  The highest tax rate, however, is reserved for property passing to “firms.”  The estate argued that because the transfer was made to a partnership that was owned solely by collateral descendants (an heir that is not a direct descendant, but is a brother, sister, aunt, uncle, cousin, nephew, niece or parent), the transfer should be taxed as if individually received by that class of descendants.  The IDOR disagreed, noting that Iowa Code §450.10 treats a partnership as a unit without taking into consideration the individual members.  As a result, the top rate of 15 percent tax rate applicable to a “firm” should be imposed.  Estate of Patterson, IDOR Letter of Finding No. 07-70-2-0003 (May 10, 2007).