IRS Scrutiny of Discounted Family Limited Partnerships: What Florida Families Need to Know

Family Limited Partnerships (FLPs) are a popular estate planning tool that can help families transfer wealth while potentially reducing estate and gift taxes through valuation discounts. Because these discounts can significantly lower asset values for tax purposes, the IRS closely scrutinizes FLPs to ensure they serve legitimate estate planning objectives. Improperly structured or managed FLPs can trigger audits, tax adjustments, and penalties. Here is what to know about FLPs so that you can create and maintain an FLP that complies with IRS rules while protecting your family’s wealth.

What Exactly is an FLP?

An FLP is an estate planning tool that allows family members to pool, manage, and transfer wealth through a formal partnership structure. FLPs are commonly used by families with significant assets, including real estate, investment portfolios, closely held businesses, and other valuable property. The structure is designed to help preserve family wealth, maintain centralized management, and facilitate the transfer of assets from one generation to the next.

An FLP typically has two types of partners: general partners and limited partners. The general partners—often parents or senior family members—retain control over management decisions and oversee the partnership’s assets. Limited partners, usually children or other heirs, receive ownership interests but generally have limited control over daily operations. 

What are the Main Benefits of the FLP?

An FLP can provide many benefits. Here are some of the most common:

Valuation Discounts on Transferred Interests

• FLPs may allow families to apply valuation discounts when transferring limited partnership interests, potentially reducing the taxable value of those interests.
• Because limited partners have less control and fewer rights than business owners or controlling partners, their interests may be worth less than their proportional share of the partnership’s underlying assets.

Lack-of-Control Discount

• This discount recognizes that limited partners cannot make major decisions about the partnership’s assets, investments, or operations.
• Since minority owners have limited voting power and decision-making authority, their ownership interests may be valued at a lower amount.

Lack-of-Marketability Discount

• This discount reflects the difficulty of selling private partnership interests.
• Limited partnership interests often have reduced value because there is no public market for them and partnership agreements may restrict transfers.

Reduced Gift and Estate Tax Exposure

• By lowering the taxable value of transferred partnership interests, FLPs may allow families to transfer more wealth to future generations while reducing potential gift and estate tax costs.
• This can help families preserve more assets for heirs and improve the efficiency of wealth transfers.

Asset Protection

• FLPs can help protect family assets by placing them within a structured legal entity.
• This structure may provide safeguards against certain risks and help maintain control over valuable family assets.

Prevention of Ownership Fragmentation

• FLPs help prevent important family assets from being divided among multiple heirs.
• Instead of splitting ownership of assets such as businesses or real estate, heirs receive partnership interests while the assets remain together under the FLP.

What Will the IRS Look For?

While FLPs can be a valuable estate planning strategy, they remain one of the structures most closely examined by the IRS. The primary area of concern is the use of valuation discounts when transferring limited partnership interests to family members. While discounts for lack of control and lack of marketability may be appropriate in certain situations, the IRS often challenges arrangements where the discounts appear excessive or where the partnership lacks a legitimate purpose beyond reducing taxes.

In cases where taxpayers seek significant valuation discounts, courts closely evaluate whether the FLP was formed for genuine business or investment reasons, whether the partnership operated as a separate entity, and whether the taxpayer respected all required formalities. Factors such as commingling personal and partnership assets, retaining too much control over transferred assets, or creating the partnership shortly before death can increase the likelihood of an IRS challenge.

The IRS may argue that the value of transferred interests should not be reduced by claimed discounts if the arrangement does not reflect a true transfer of ownership. For example, if a family member contributes assets to an FLP but continues using those assets as personal property, the IRS may seek to include those assets in the taxable estate or deny the requested valuation adjustments.

Frequently Asked Questions 

Are FLPs legal in Florida?

Yes. When properly established and operated in compliance with Florida law and applicable federal tax regulations, they can be a great tool for estate planning, asset protection, and wealth transfer. 

What strategies can we use to avoid IRS scrutiny? 

To withstand IRS scrutiny, families should establish a clear purpose for their FLP beyond tax savings, such as managing investments, preserving family assets, or planning for future generations. Maintaining accurate records, obtaining independent valuations, keeping finances separate, and following partnership requirements are critical. For Florida families incorporating FLPs into their estate plans, valuation discounts are not guaranteed. 

Can the IRS audit a FLP?

Yes. The IRS may audit an FLP to determine whether valuation discounts and the partnership’s structure comply with tax laws. During an examination, agents may review partnership agreements, asset appraisals, transfers, distributions, business purpose, recordkeeping, and more. 

Who are FLPs for?

FLPS may be a good option for families with significant assets, closely held businesses, investment properties, or other wealth they want to preserve and transfer efficiently. They are often used by individuals seeking greater control over family assets while creating a structured plan for succession and wealth transfer. 

Contact An Experienced Estate Planning Attorney 

FLPs can be an effective way to preserve wealth and transfer assets to future generations when properly structured. However, because the IRS closely scrutinizes valuation discounts, it is best to have an experienced Florida estate planning attorney review the FLP. He or she can help create a strategy that maximizes the benefits of an FLP while reducing the risk of IRS challenges. Contact our office today.