Blackman on Taxes
Family Limited Partnerships: Ensure You and Your Family Win, and the IRS Loses
To win the estate-tax game requires a comprehensive plan—really two plans, an estate plan (death plan) and a lifetime plan (LP). The LP lays the groundwork for beating the estate tax.
The best LP is asset based. There are four types of assets:
• Qualified funds (i.e., in a 401(k), IRA or the like)
• Investments (stocks/bonds/cash/real estate—owned alone or with others—and similar assets)
This article zeros in on investments.
Let’s call our tax hero Joe, who has accumulated a variety of investment-type assets worth $12 million. Joe and his wife Mary have three children and six grandchildren. Joe has considerable wealth in all four types of assets. His goals concerning the investment assets:
• Reduce (or eliminate) the potential estate tax
• Reduce income tax on the assets’ income
• Protect the assets from creditors and divorce (ex-in-laws if kids or grandkids get divorced)
• Keep control of the assets
You’ll Flip over FLIPs (Family Limited Partnerships)
No question about it, a FLIP (sometimes more than one) is the weapon of choice to accomplish all of Joe’s goals. FLIPs are so effective that since 1985 all 50 states have adopted the Revised Uniform Limited Partnership Act.
A FLIP is a partnership consisting of one or more voting general partners (i.e., who control management and make investment decisions) and limited partners (receive nonvoting units). Unlike irrevocable trusts, a FLIP is a flexible tool that can be amended if necessary to meet the changing needs of your family or circumstances.
Since the limited partnership units are unable to vote or control investments or distributions, they qualify for valuation discounts. These discounts typically reduce the value of the property (for tax purposes) transferred to the FLIP in the 30- to 40-percent range. We typically take 35-percent discounts, even for stocks, bonds, cash or cash-like assets, which the IRS has always accepted.
Discounts are a big deal. For example, if Joe transfers $1 million of investment-type assets, the $350,000 discount will save $140,000 in estate taxes—using the 2013 top 40-percent estate-tax rate.
Joe and Mary (both 61 years old) want to shift their investment asset value and the accompanying income—free of gift and estate taxes—to their children and grandchildren. Here’s how the creation and operation of a FLIP performs that job perfectly.
1) A FLIP agreement creates a general partnership interest to own one percent and a limited partnership interest to own 99 percent of the FLIP. To start, Joe and Mary own all interests (units).
2) Joe and Mary transfer $10 million (only $6.5 million for tax purposes after discounts) of various investment assets to the FLIP in exchange for the general and limited partnership units. The transfer is tax-free.
3) Joe and Mary retain the general partnership units for their lifetime, while the limited partnership units are gifted over time directly to (or via a trust for the benefit of) the children and grandchildren.
4) As general partners, Joe and Mary control the investment and management of the FLIP assets. They must receive adequate compensation for services rendered to the FLIP, but they can hire others to manage and perform required services.
5) We actually created two FLIPs. FLIP 1 is for assets likely to appreciate in value; FLIP 2 holds the remaining assets. For asset-protection purposes, all of the real estate was put into a series of limited liability companies (LLCs) and the interests in the LLCs were transferred to the FLIP.
6) Now we are ready to get down to business—gifting the FLIP limited partnership units to the kids and grandkids in the most tax-effective way. Here’s what we did:
a) Gave all of FLIP 1’s limited-partnership units to the three kids, using up $4.8 million of their unified credit—$5.25 million each for Joe and Mary in 2013. Immediately, the appreciating assets and the income from these assets are out of their estate.b) We started an annual gifting program using the $14,000 (the annual exclusion for 2013), or $28,000 for Joe and Mary combined—a total of $252,000 per year ($28,000 times all nine of the kids and grandkids). It will take Joe and Mary seven years to complete gifting the FLIP 2 limited partnership units. Note: The units owned by the kids and grandkids are protected from their creditors or ex-spouses in case of a divorce. MF
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