One of the simplest and most straight-forward approaches to reducing the size of your taxable estate is to make tax-free annual exclusion gifts.
 Nick Garry
Today, the asset most often gifted is cash. It’s simple and may be attractive when an alternative asset has a very low basis.
From a leverage standpoint, however, cash is generally not the best asset for gift-giving.
If you can give an asset that’s worth $12,000 after reduction by a one-third discount, that is really a $17,910 tax-free gift. Of course, cash isn’t discountable – $12,000 in cash is always valued at $12,000. The challenge is finding an asset that allows you to squeeze an additional $6,000 out of each gift. Doing so allows for significant leverage, instantaneously.
Making discounted gifts often involves the use of limited partnerships or limited liability companies.
The IRS has made it clear, in recent rulings, that there must be a valid business purpose to these entities. In a typical arrangement, the donor contributes assets, such as a business, real estate or securities in exchange for general and limited partnership interests. General partners manage the partnership and are the only partners who can legally bind the partnership in contracts. Limited partners cannot participate in management but can be employees.
When making annual exclusion gifts, the value of the assets transferred is the fair market value at the time of the gift. However, a major benefit that often applies when gifting limited partnership units is that a donor may be able to give away the units at a discount to the fair market value. Two types of discounts exist: a discount for lack of control and a discount for lack of marketability.
The theory behind a control discount is that a limited partner interest is less attractive to a hypothetical buyer because limited partners have little control over the partnership or the underlying assets.
Limited partnership interests may be less marketable than the underlying assets. Anyone trying to sell a limited partner interest might find it difficult to locate a willing buyer, unless the seller was willing to give the buyer a deep discount.
Greater leverage may be obtained if the partnership assets are highly appreciating. This is because all future appreciation of gifted assets is removed from your taxable estate as well.
Do be aware that the IRS might challenge the amount of discount a donor takes. This makes it crucial to obtain a valuation of the underlying assets and the partnership interests.
There are risks and considerations associated with any financial strategy; therefore, before proceeding, you should discuss a plan with your professional advisors.
Nick Garry is a CPA and personal financial specialist at Garry Associates LLP
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