Transferring
assets or income producing property to children or other family members
can be a valuable tool in income and estate tax planning. Income can be shifted to an
individual in a lower tax bracket than the donor, and transfer of a
present interest in a partnership can represent a future increase in
value. However, IRC §704(e) sets forth restrictions relating to the
transfer of partnership interests to family members by sale or gift.
Regulation §1.704-1(e) contains special
rules intended to make sure that income from partnerships is "taxed
to the person who earns it through his own labor and skill and the
utilization of his own capital." If a transfer does not include full
"dominion and control" of the partnership interest in a bona
fide transaction, the IRS may not allow the transfer for tax purposes.
Family members will be recognized as
partners only if one of the following requirements is met:
1) If capital is a material
income-producing factor, a family member partner must acquire his/her
capital interest in a bona fide transaction (purchase or gift from another
family member), actually own the partnership interest, and actually have
control over the interest.
2) If capital is not a material
income-producing factor, the family member partner must provide
substantial or vital services to the partnership.
Family includes only spouses, ancestors,
and lineal descendants, or any trusts for their benefit. Brothers and
sisters are not included.
