Family Limited Partnerships

The family limited partnership (FLP) is often called the the creme de la creme of estate planning strategies. It collects a mound of mouth-watering ingredients (assets) into one bowl that satisfies any invited to taste it. FLPs have long been recognized for their ability to preserve and enhance family wealth, while at the same time resulting in significant estate and gift tax savings.

The FLP is comprised of one or more general partners who control the FLP and one or more limited partners who are merely passive investors and therefore have no say in the management of the FLP.  One of the benefits to being a limited partner is that the limited partners' liability is limited to their initial investment.  The creditors of the FLP cannot pursue the limited partners personally for debts of the FLP.  The general partners control and manage the FLP.  General partners are personally liable to the FLP's creditors to the extent the FLP cannot pay its debts.

The Family Limited Partnership also helps avoid intra-family disputes, because the limited partnership interest can generally be restricted to the members of the family. This is true even with a divorce. If the partnership interest was transferred in a divorce proceeding, it still would not be a valuable asset, as the recipient would not be able to dissolve the partnership, remove the general partner or force distributions of income from the partnership. A family limited partnership protects against third parties acquiring an interest in the partnership.

Estate and Gift Taxation
 
The Estate and Gift Tax
 
Every individual is permitted to give away during his or her lifetime or at death an amount equal to their "applicable exclusion amount." The applicable exclusion amount in 2001 is $675,000; by 2009, the applicable exclusion amount will increase to $3,500,000. To the extent that a taxpayer's taxable estate exceeds the applicable exclusion amount, a taxpayer's estate is responsible for an estate tax based on the fair market value of the assets in the taxable estate.  In 2001, the estate and gift tax rate schedule contemplates a marginal tax rate of 37% for amounts in excess of the $675,000 exemption and incrementally increases to 55% for estates worth $3,000,000 or more. Between now and 2009, top estate and gift tax rates will gradually drop from 55% to 45%.
 
The Annual Exclusion
 
In addition to the $675,000 exemption, current federal gift tax law allows an individual to make yearly gifts of $10,000 to as many recipients as he or she desires without being required to pay a gift tax or otherwise reduce the donor's $675,000 exemption.  This $10,000 "annual exclusion" allows an individual to reduce his taxable estate by making current gifts of property.  By making a current gift, not only are the gifts removed from the taxable estate, but any future appreciation is also removed.  For maximum effectiveness, it is often recommended that gifts be made of assets that are expected to substantially appreciate.
 
Valuation Discounts
 
 A major benefit of contributing assets to the FLP is that the values of the FLP interests are often less than the value of the assets held by the FLP.  The combined value of the FLP interests of a FLP which holds an interest in real estate worth $1,000,000 may be only $700,000 if a 30% "entity discount" is warranted.  This $300,000 "discount" is worth $165,000 in estate tax savings to an estate in the 55% marginal tax bracket and approximately $111,000 to an estate in the 37% marginal tax bracket.  The discount in value is attributable to the fact that the FLP agreement normally imposes restrictions on the sale of FLP interests and may reduce the partners' right to control the partnership assets.  These "restrictions" may in fact be desired control features which promote family unity and harmony, centralize control and, at the same time, reduce transfer taxes. 

FLP Examples:

First, assume that Mrs. Smith has a $3,000,000 investment portfolio. Assume further that Mrs. Smiths’s children are caretakers and that she has no concern about control of her investments. If nothing is done, upon death the $3,000,000 will be included in the decedent’s gross estate, thereby generating a tax in the range of $1,400,000.

Savings of $470,000?

If Mrs. Smith creates a limited partnership naming her children as general partners with a 1% equity interest and herself as limited partner with a 99% interest, the $3,000,000 can be contributed to the partnership. Prior to the contribution, a gift of $30,000 can be made to the children so that they can make their pro rata contribution. Upon death, instead of reporting ownership of $3,000,000 worth of cash, stocks, and bonds, the estate tax return will include a 99% limited partnership interest in a partnership worth $3,000,000 (assuming no change in value between the time of contribution and the time of death). The limited partnership interest can be discounted to something less than the value of the underlying assets. Using a one-third discount, which many valuation experts consider too modest, the reduction in asset value of about $1,000,000 will save approximately $470,000 in taxes.

Or save $1,800,000 for the family?

The second and somewhat more complicated example involves a sale by Mrs. Smith of the limited partnership interest to a particular kind of irrevocable trust that she establishes for her descendants. The purchase price will be determined using the same discounting approach. The trust will issue a promissory note—$2,000,000 in this example—to represent the purchase price. If the assets of the partnership double between the time of the sale and the time of death, inclusion in the estate of the $2,000,000 promissory note instead of $6,000,000 worth of assets will reduce the estate by $4,000,000 and save something on the order of $1,800,000 for the family. As impressive as this potential savings might seem, it pales in comparison to the many millions of dollars that can potentially be saved for future generations; that is, upon the death of children, grandchildren, and so on. In the meantime, for at least several hundred years the assets can be protected in the trust from divorce and other creditor problems.

Forming a FLP can be extremely complex. To learn more about forming your own FLP, please call a Summit Trust Advisor at 702-315-0560.

Limited Liability Companies

What is a Limited Liability Company?

A limited liability company (LLC):

Is a type of business ownership combining several features of corporation and partnership structures

Is not a corporation or a partnership

May be called a limited liability corporation, the correct terminology is limited liability company

Owners are called members not partners or shareholders

The number of members are unlimited and may be individuals, corporations, or other LLC's

  Is not as complicated as forming a FLP, but can be just as effective.

An LLC also provides tax advantages to transfer wealth from one generation to another while allowing the donor to maintain control over over the assets until death.

An LLC consists of members and managers. It can be structured like a limited partnership, with the members being passive investors and the managers actively managing the company. The concepts of wealth transfer are the same for LLCs and limited partnerships: The generation transferring the wealth (the parents) forms an LLC, making themselves both managers and members. The generation receiving the wealth (the children) are made members of the company. Initially, the parents hold all of the membership interest in the company along with the assets it represents. Over time, the membership interest is gifted to the children, within allowable gift tax amounts, and the parents retain the control of the company and its assets as the managers. LLCs can be structured to allow flexibility to accommodate income distribution issues and restrictions on transfers of interests.

Like shareholders of a corporation, all LLC owners are protected from personal liability for business debts and claims. This means that if the business itself can't pay a creditor -- such as a supplier, a lender, or a landlord -- the creditor cannot legally come after any LLC member's house, car, or other personal possessions. Because only LLC assets are used to pay off business debts, LLC owners stand to lose only the money that they've invested in the LLC. This feature is often called "limited liability."

You should consider forming an LLC (limited liability company) if you are concerned about personal exposure to lawsuits arising from your personal business. For example, if you decide to open a store-front business that deals directly with the public, you may worry that your commercial liability insurance won't fully protect your personal assets from potential slip-and-fall lawsuits or claims by your suppliers for unpaid bills. Running your business as an LLC may help you sleep better, because it instantly gives you personal protection against these and other potential claims against your business.

LLCs and Estate Planning

Sophisticated estate plans typically utilize arrangements which facilitate the gifting of assets to the next generation at a discounted value to reduce the ultimate taxable estate. For example, individuals are allowed to make tax free gifts of up to $11,000 annually to anyone they choose. If a discount of, say, 35% is applied to the gift, then $16,800 could be gifted to each person because the discounted value would not be more than $11,000.

LLCs may also be an important component in such gift planning. For example, assume that a married couple with three adult children establishes a LLC and transfers $500,000 of real estate into it in exchange for 100% of the outstanding shares. The couple could make annual tax-free gifts of stock to their children. Since the children's shares would not be freely transferable and would not give any one child control over the LLC, applicable tax law allows us to apply a 35% discount to the value of the shares for purposes of determining the amount of the taxable gift. This allows each parent to give a 3.36% interest in the LLC to each child each year ($16,800 per year -- $10,920 net after a 35% discount is applied). In this manner, the couple can gift $100,800 worth of LLC shares each year to the children, gift tax-free ($16,800 x 3 children x 2 parents = $100,800). In just under five years, the property could be gifted away, tax-free.

Alternatively, the parents could choose to retain all of the voting shares to retain control of the entity until their deaths and then leave the voting shares to the children in their wills/trusts. This may be particularly desirable where the parents have the expertise to run the business or manage the real estate, and the children do not. The beauty of gifting through an LLC is that the annual gifts are accomplished with a one-page document signed and filed with the LLC organizational documents. No further recordings at the Registry of Deeds are necessary.

To Learn more about Nevada LLC's, please click here.