To win the estate tax game, you must have a comprehensive plan. Really two plans would be best: 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. You can have four types of assets: residences; businesses; qualified funds (in a 401(k), IRA or the like); and investments, such as stocks, bonds, cash, real estate and similar assets. This article zeros in on investments, an area where almost all professional advisors are at a loss of what to do and how to do it.
Let's call our tax hero "Joe," who has accumulated a variety of investment-type assets worth $12 million. He is married to Mary, has three children and six grandchildren. Joe has considerable wealth in all four types of assets, but his goals concerning the investment assets are: 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); and keep control of the assets.
You'll flip over FLIPs
No question about it, a Family Limited Partnerships(FLIP) 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 (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 are eligible for valuation discounts. These discounts typically reduce the value of the property (for tax purposes) transferred to the FLIP in the 30% to 40% range. We typically take 35% discounts, even for stocks, bonds, cash or cash-like assets, which always have been accepted by the IRS.
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%, 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. Following is an example of the creation and operation of a FLIP that does the job perfectly.
1. A FLIP agreement creates a general partnership interest to own 1% and a limited partnership interest to own 99% 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. The general partnership units are retained by Joe and Mary 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 No. 1 for assets likely to appreciate in value and FLIP No. 2 for the rest of the assets. For asset protection purposes, all 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. Our business is gifting the FLIP limited partnership units to the kids and grandkids in the most tax effective way. After considering the overall comprehensive plan for all the other assets owned by Joe and Mary, this is what we did:
a) Gave all of FLIP No. 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) Next, 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 No. 2 limited partnership units. It should be noted that units owned by the kids and grandkids are protected from their creditors or ex-spouses in case of a divorce.
If you have a significant amount of investment assets, a FLIP (or two) will help you win the estate tax game. One warning: Only work with advisors who have experience doing comprehensive plans: death, estate and lifetime plans. Want to learn more? Browse my website at www.taxsecretsofthewealthy.com. Or call Irv at 847/674-5295.
Irv Blackman, CPA and lawyer, is a retired partner of Blackman Kallick LLP and chairman emeritus of the New Century Bank, both in Chicago. He can be reached at 847/674-5295, e-mail [email protected], or on the Web at: www.taxsecretsofthewealthy.com.