It is this voting control to admit new partners into the partnership, among other things, that provides the difficulty of a creditor in becoming a substituted partner into the family limited partnership.
Many practitioners feel that other common restrictions on transferability will meet the "comparability test" under IRC §2703, such as requirement for the consent of only the general partner and/or right of first refusal provisions.
Placement of the investment portfolio in a family limited partnership provides this flexibility. Retention of Younger Generation Initiative — An often-expressed fear of the older generation is that a substantial transfer of wealth too early stifles the initiative of their children to produce through work. Ownership of Units — While differing fact patterns may dictate other structures, this author often creates a Texas limited partnership, now governed under the Texas Business Organizations Code, with 100 partnership units: one general partner unit and 99 limited partner units.
Since retention of management, including the power to make distributions to younger generation limited partners, is a fundamental feature of essentially all family limited partnerships, the older generation can completely control the cash flow to their children and encourage productive work habits. The predominant spouse (or a revocable trust with such spouse as trustee) contributes 1 percent of the marital assets going into the family limited partnership in exchange for the one general partner unit.
On the other hand, many professionals advise that multiple financial managers are necessary to, among other things, achieve more diversification of the various portions of the family's total investment portfolio, outweighing the benefit of reduced fees and other costs. Flexibility in Portfolio Mix — Oftentimes, in the irrevocable trust scenario, the trustee is not allowed to use sound portfolio investment principles because of concern of treating either the income beneficiary or the remainder beneficiary unfairly.
An income beneficiary's interest increases if the portfolio contains investments generating larger income, usually in the form of dividend or interest income, while a remainder beneficiary's interest is enhanced through investments that appreciate in value.
Chapter 14, IRC §2701 — IRC §2701 was designed primarily to address the traditional corporate and partnership recapitalizations that seek to "freeze" the value of senior generation interests and shift appreciation to junior generation interests.
For example, in the corporate context, the recapitalization was accomplished with preferred stock retained by the senior generation and common stock gifted to the junior generation.
However, non-lapsing differences with respect to management and limitations on liability do not create separate classes of interest for this purpose. In the family limited partnership context, involving so-called "straight up" interests, IRC §2701 should not apply since there are not two classes of interests, with retained special distribution rights or liquidation rights attached to one of such classes. Chapter 14, IRC §2702 — IRC §2702 was designed primarily to address retained interests in trusts and is generally not applicable in the family limited partnership context. IRC §2703 contains rules governing the tax impact of certain buy-sell agreements and similar arrangements designed to limit or restrict the value of interests in family-controlled partnerships and corporations. IRC §2703: The Lead Case - , the Tax Court rejected the IRS argument that "a right or restriction may be implicit in the capital structure of an entity" by stating:"Respondent (IRS) next argues that the term "property" in section 2703(a)(2) means the underlying assets in the partnership and that the partnership form is the restriction that must be disregarded. IRC §2703: Conclusions — Many practitioners believe that IRS attacks on validly formed limited partnerships based on IRC §2703 will continue to be fruitless (on the IRS' part) under the rationale that the term "property" cannot refer to the partnership assets themselves, since such assets are not part of the transferor's estate (the partnership interests are), thus, rendering IRC §2703(a) non-applicable to the valuation of the partnership interests.If these assets are placed in a family limited partnership, the resulting limited partner units can be used as "family money" to conveniently gift or devise the equivalent of undivided interests of all of the assets to family members.If the gifts of limited partnership units qualify for the annual exclusion, the same discount methods of valuation discussed in Section VII below will apply, so that a greater value can be gifted to family members without potentially incurring a gift tax.Even if the divorce court were to award part of the limited partnership units to a divorced spouse, a properly drafted family limited partnership agreement would provide that involuntary transfers are subject to repurchase options, so that retention of family assets can be maintained by the family. Revocability — One major disadvantage of the irrevocable trust, which also has substantial asset protection features, is that it cannot generally be lawfully amended or terminated without participation by a court and, possibly, other parties such as a guardian ad litem for minor children or other incapacitated beneficiaries.The family limited partnership agreement may be amended or terminated if the designated vote of the partners (in a family limited partnership, comprised of family members) can be obtained. Generation to Generation Retention — Since a well-drafted family limited partnership agreement will contain consent requirements and/or purchase option provisions on the attempted transfer of any partner of his or her partnership units, the assets can be effectually retained in the family for the duration of the partnership. Reduction of Investment Portfolio Costs — Families may have many members, as well as trusts set up on their behalf, resulting in costly maintenance of separate investment accounts for multiple family member investors.