The Internal Revenue Code prescribes minimum imputed interest rates and time-value-of–money factors applicable to certain loan transactions and estate planning techniques. These rates are tied formulaically to market interest rates. The Internal Revenue Service updates these rates monthly.
These are commonly applicable rates in effect for October 2014:
Short Term AFR (Loans with Terms <= 3 Years) 0.38%
Mid Term AFR (Loans with Terms > 3 Years and <= 9 Years) 1.85%
Long Term AFR (Loans with Terms >9 Years) 2.89%
7520 Rate (Used in many estate planning vehicles) 2.2%
Here is a link to the complete list of rates: http://www.irs.gov/pub/irs-drop/rr-14-26.pdf
E. John Wagner, II
Non-controlling family partnership interests with limited marketability have long been discounted for federal gift and estate tax valuation purposes, reducing their deemed fair market value and the gift and estate tax attributable to such interests. The income tax tradeoff for a partnership interest held until death is that the income tax basis in the partnership interest is lower to the inheritor, because that tax basis is automatically adjusted to fair market value. A lower tax basis potentially creates more taxable gain when the asset is later sold.
The tradeoff was traditionally tolerated because the federal gift and estate tax rate was higher than both ordinary income and capital gain tax rates. Since the federal estate and gift tax exemption increased to over $5 million per individual and over $10 million per married couple a few years ago, however, many families’ estate tax exposure has disappeared. For families with no ongoing estate tax exposure, valuation discounts that once made their family partnerships “tax assets” may now make the partnerships “tax liabilities.” Even though they may no longer have estate tax to avoid, the families are still left with a lower mark-to-market tax basis and potentially more future taxable gain after a family member dies.
Also, with recent changes in the law, the highest marginal federal income tax rate and the federal estate tax rate are now very close. For assets that produce ordinary income when sold for a gain, this reduces or reverses the estate-income-tax-rate arbitrage even for families with continuing estate tax exposure.
Should families unwind their family partnerships?
For families affected by these factors, it is worth asking the question anew. The question should be evaluated in the context of the many advantages and disadvantages–including non-tax factors–that characterize family partnerships.
In contrast, families with ongoing estate tax exposure whose family partnerships hold assets that will likely produce capital gain when sold are less likely to be affected by these factors. Their family partnerships likely remain effective estate planning tools.
E. John Wagner, II
In a recent ruling, the IRS confronted a partnership serving as a management company for investment partnerships and funds. Management fees were its sole source of income. The management company paid reasonable compensation subject to employment or self employment taxes to its owner-managers. Following a planning technique available to S corporations, the partnership treated its partner distributions as being exempt from self employment taxes. The IRS disagreed with the partnership’s position. The IRS ruled that the partner distributions were subject to self employment taxes notwithstanding the reasonableness of compensation paid as such to its owner-managers.
The ruling is significant because distributions from an S corporation structured in the same way probably would not have been subject to self employment tax. Indeed, the partnership in question used to be an S corporation, and the IRS specifically held that the S corporation rules do not apply to the new partnership.
The ruling underscores an evolving IRS position that treats service S corporations and service partnerships differently for self employment tax purposes. While technically understandable because different statutory and regulatory provisions govern the different entity types, the differing self employment tax treatment of these entities defies common sense.
Unless a sensible unified self employment tax policy emerges, when possible it remains wise to structure management or service companies either as S corporations or as partnerships with S corporation partners, to take advantage of the more flexible self employment tax planning options available for S corporations.
Here is link to the ruling: http://www.irs.gov/pub/irs-wd/201436049.pdf
E. John Wagner, II