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A Teleconference from Business Valuation Resources 1-888-BUS-VALU (287-8258) bvresources

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A Teleconference from Business Valuation Resources 1-888-BUS-VALU (287-8258) bvresources

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  1. Fighting Legal Pitfalls with Family Limited Partnerships:A Practical Guide for Forming, Operating, and Defending FLPs A Teleconference from Business Valuation Resources 1-888-BUS-VALU (287-8258) February 22nd, 2007 Moderator: Stephanie Loomis-Price of Baker Botts L.L.P. Panelists: Garry L. Marshall, CFA of Howard Frazier Barker Elliott, Inc. Paige Ben-Yaacov of Baker Botts L.L.P.

  2. Ancillary Reading Materials • Fighting Legal Pitfalls with Family Limited Partnerships: A Practical Guide for Forming, Operating, and Defending FLPsPDF and PowerPoint Presentation • Full court texts and Business Valuation Update abstracts for: • Caracci v. Commissioner (Tax Court and 5th Circuit) • Estate of Schutt v. Commissioner • Estate of Bongard v. Commissioner • Estate of Stone v. Commissioner • Estate of Rosen v. Commissioner • Lappo v. Commissioner • McCord, et al. v. Commissioner (Tax Court) and Succession of McCord, et al. v. Commissioner (5th Circuit) • Peracchio v. Commissioner • Senda v. Commissioner (Tax Court and 8th Circuit) • All downloads and links available at the ancillary reading page:

  3. Learning Objectives • Determine when it is not feasible to create a family limited partnership • Optimize family limited partnership formation to avoid IRS attacks • Advise clients on proper family limited partnership operation • Maximize benefit of interaction with appraiser • Counsel clients during IRS examination of family limited partnerships

  4. Submitting Questions • Email tc-questions@bvresources.comat any time during the Teleconference • The conference operator will provide instructions on how to join the queue during the audience Q & A portion of the call

  5. Consider Appropriateness of Partnership 1. Keep your potential future audience in mind • Consider what you write – email, memo to file regarding reasons for partnership formation, time records (for attorneys/accountants), letters, etc. • The IRS, a judge, or even a jury may eventually be reviewing documents written during the planning stages • Consider and document all substantive non-transfer tax reasons that fit the situation; avoid a template laundry list

  6. Consider Appropriateness of Partnership 2. Consider whether clients are ready for a partnership • Sophistication of clients • Willingness to comply with Partnership Agreement's terms • Willingness to pay professional fees over time

  7. Consider Appropriateness of Partnership 3. Evaluate potential assets • "Risky" assets should be segregated from other assets • No retirement plans, IRAs, etc. • No stock in S-corporations • Contributions of stock in a closely-held corporation requires analysis of § 2036(b) of Internal Revenue Code

  8. Consider Appropriateness of Partnership 3. Evaluate potential assets [continued] • No personal use assets • Partners should retain enough assets outside Partnership to support lifestyle • If assets that are hard to value are contributed to the Partnership, partners will need appraisals to calculate initial ownership interests in Partnership • Transfer restrictions on any assets need to be reviewed and appropriate consents obtained

  9. Consider Appropriateness of Partnership 3. Evaluate potential assets [continued] • If real estate or other non-liquid assets will be contributed to the Partnership, the Partnership will need enough cash to maintain those assets • Contribution of assets subject to debt (margin debt, mortgages, etc.) requires consideration of income tax issues • Investment company rules should be analyzed

  10. Consider Appropriateness of Partnership 4. Evaluate potential partners • Consider health of partners • Meaningful contributions by partners

  11. Consider Appropriateness of Partnership 5. Engage/consult with advisors who have experience in this area • Avoid “kit partnerships” • Any attorney/accountant who will be involved with the Partnership should be consulted sooner rather than later

  12. Partnership Formation 1. Counsel Partners to discuss following partnership terms: • Management structure • Compensation to be paid to managers • Investment policy • Expected distributions • Transfer restrictions on partnership interests • Term of partnership

  13. Partnership Formation 2. Consider separate counsel for some (or all) participants • Discuss terms of Partnership Agreement • Partners should read and understand terms of the Partnership Agreement

  14. Partnership Formation 3. Ensure that Schedules to Partnership Agreement are complete • Partnership Agreement should accurately set forth assets contributed to Partnership and ownership interests in Partnership

  15. Partnership Formation 4. Prepare deeds and transfer documents prior to formation date • Ensure transfer of title of all assets to Partnership • Have parties sign transfer documents at the same time as Partnership Agreement and related formation documents • Ensure that partners own assets to be contributed before Partnership is created

  16. Partnership Formation 5. File for Employer Identification Number (EIN) soon • Upon receipt of Certificate of Limited Partnership

  17. Partnership Formation 6. Create Partnerships bank/brokerage accounts in a timely manner

  18. Partnership Formation 7. Engage a good partnership accountant • Accounting issues could make or break court’s view of whether to respect existence of Partnership • Initial ownership interests should not change in the absence of additional capital contributions, redemptions, sales, etc. • I.R.C. Section 754 elections • Protective claims • Audit procedures

  19. Partnership Formation 8. Ensure that partners receive interests in the Partnership in proportion to the fair market value of the assets contributed by each to the Partnership • Correctly reflect the fair market value of the assets contributed in the respective partner’s capital account

  20. Partnership Formation 9. Consider amortizing partnership set-up fees

  21. Partnership Formation 10. If necessary, amend Partnership percentages as quickly as possible after formation • If assets were contributed to the Partnership but the value was not known on the date of formation (such as is likely to be the case with hard-to-value assets), amend the percentages as soon as information on all contributed assets becomes available

  22. Partnership Formation 11. Be prepared to produce documents in your file to the IRS, if necessary • The best evidence of formation rationale often comes from the correspondence prepared in connection with the transaction; Keep your potential audience in mind • Assertion of privilege may lead to negative inferences

  23. Partnership Maintenance 1. Consider filing tax returns for each year in existence

  24. Partnership Maintenance 2. File any annual/bi-annual registration statements required by relevant state authorities

  25. Partnership Maintenance 3. Comply with terms of Partnership Agreement • Are periodic meetings required? At any meeting, consider taking minutes, even if not required by Partnership Agreement • Are annual statements (other than tax returns) required? • Are annual distributions required? • Are payments on preferred interests required?

  26. Partnership Maintenance 4. Consider keeping charities involved • If a charity has an interest in the Partnership, keep the charity involved in the Partnership for as long as practicable

  27. Partnership Maintenance 5. Comply with loan terms, if loans are made • Beware lending from the Partnership to family member • Any loans made by the Partnership should comply with the terms of the Partnership Agreement • Any loans should be properly documented • Loan terms should be reasonable • Payments should be made timely

  28. Partnership Maintenance 6. Make any distributions pro rata • Make sure that all distributions are pro rata (proportionate to percentage interests in the Partnership) • If you discover a non-pro rata distribution, consider a “make-up” distribution with interest

  29. Partnership Maintenance 7. Refrain from use of Partnership assets for Partners’ personal obligations • If a partner dies and the partner’s estate needs funds, consider having the estate sell a partnership interest or borrow money, rather than making distributions from the Partnership • Personal use assets

  30. Partnership Maintenance 8. If a partner dies or transfers an interest in the Partnership, consider whether to make a Section 754 election

  31. Partnership Maintenance 9. Avoid multiple transactions between partners and Partnership • Loans • Redemptions • Non-regular distributions • Non-pro rata distributions

  32. Partnership Maintenance 10. Review the non-tax reasons you stated for forming the Partnership and follow them • Involvement of family members • Asset management • Avoidance of fractionalization

  33. Transfers of Partnership Interests 1. Generally • Ensure books and records of Partnership are in order • Consider whether transfer triggers any rights of first refusal • Keep track of changes in partnership interests

  34. Transfers of Partnership Interests 1. Generally [continued] • Consider restating schedule or exhibit to Partnership Agreement that indicates ownership interests • Consider keeping historical spreadsheet showing changes at each transaction • Document the transfer to be executed by transferor and transferee • Date the transfer document --- effective date vs. date signed • Review Partnership Agreement to determine how redeemed interest is to be valued

  35. Transfers of Partnership Interests 2. By Gift or Sale • Review Partnership Agreement to ensure compliance with terms • Refrain from gift planning until Partnership is formed and operating • Consider income tax issues (on sale) • Ensure that changes in percentage interests are reflected in books and records of Partnership • Ensure that the Certificate of Limited Partnership is amended, if necessary

  36. Transfers of Partnership Interests 3. At Death • Review Partnership Agreement to determine character of interest passing – general partnership interest, limited partnership interest, assignee interest • Review transfer to determine whether a lapse occurs –see I.R.C. § 2703 • Review Partnership Agreement to determine whether Executor steps into the partnership shoes of the Decedent partner

  37. Transfers of Partnership Interests 3. At Death [continued] • Consider maintaining the interest in the hands of the Executor, subject to estate administration, until a closing letter is received from the IRS • Once IRS closing letter is received, document the transfer, to be executed by executor and beneficiary

  38. Transfers of Partnership Interests 4. By Redemption • Review Partnership Agreement to ensure that Partnership is not prohibited from redeeming the interest • Document the redemption, to be executed by Partnership management and the transferring partner • Ensure that books and records of Partnership reflect decrease to transferring partner’s interest and corresponding proportionate increase to all remaining partners’ interests

  39. Transfer Tax Reporting 1. Obtain independent appraisal from qualified appraiser

  40. Transfer Tax Reporting 2. Attorney/Appraiser Interaction High level of interdependence: • Bad legal facts + Good appraisal = Bad result • Good legal facts + Bad appraisal = Bad result • Both scenarios = Unhappy client

  41. Transfer Tax Reporting 3. Confirm with the appraiser the interest to be valued • What can be transferred per the Partnership Agreement? • Is it an LP, GP, or assignee interest?

  42. Transfer Tax Reporting 4. Consider provisions of the Partnership Agreement • Level of control held by General Partner

  43. Transfer Tax Reporting 5. Consider whether to aggregate interests • Interests held in trust may be valued separately

  44. Transfer Tax Reporting 6. Provide access to client and assistance in due diligence process • Unique knowledge of family issues can impact governance • Assure that information is being communicated accurately by client

  45. Transfer Tax Reporting 7. Defensibility of valuation reports • Well documented appraisal is critical • Proper due diligence • Thorough understanding of empirical data • Relevant comparative factors • Refinement of methodology of determining discount for lack of marketability • Avoid being, or even the appearance of being, an advocate

  46. Transfer Tax Reporting 8. Review appraisal closely for facts • Distribution policy • Partnership terms • Assets • Cash flow

  47. Transfer Tax Reporting 9. Try to live by factual information provided to appraiser • Cash flow, distribution policy, etc.

  48. Transfer Tax Reporting 10. Beware of rounding on appraisals and tax returns

  49. Transfer Tax Reporting 11. Consider availability of appraiser to explain appraisal to IRS • Working relationship at different levels of controversy

  50. Transfer Tax Reporting 12. IRS Settlement Guidelines on FLPs • Goal: Consistency across different jurisdictions • Issues addressed: • Proper discounts on different asset classes • Inclusion of 2036 or 2038 transfers in gross estate • Determination of indirect gifts of assets • Applicability of accuracy-related penalties