FLIPs create perfect tax-planning strategy

Dec. 1, 2002
My clients love family limited partnerships. So do I. So do all 50 of the United States; each state has passed legislation recognizing FLIPs. And every time the IRS pokes its head up to complain about some aspect of FLIPs, the courts beat the IRS over the head. Here are a couple of recent examples: In the first case (Knight, 115 TC 36), the IRS wanted to disregard the FLIP for gift tax purposes because

My clients love family limited partnerships. So do I. So do all 50 of the United States; each state has passed legislation recognizing FLIPs.

And every time the IRS pokes its head up to complain about some aspect of FLIPs, the courts beat the IRS over the head. Here are a couple of recent examples:

In the first case (Knight, 115 TC 36), the IRS wanted to disregard the FLIP for gift tax purposes because it lacked economic substance. The Tax Count court beat up the IRS on three counts:

Since the FLIP is valid under the local law (Texas in this case), it must be recognized by the IRS. The lack of economic substance argument doesn’t hold water.

The IRS objected to any discount for the gifts of the FLIP interests (44.6%) to Knight’s two kids (22.3% to each). Sorry, said the court, allowing a 15% discount on the two FLIP interests gifted. The IRS tried to nail Knight on a technical issue involving a “family controlled entity” under Section 2704(b). Again the court said, “No.”

This next case (Estate of Elma Middleton Daily, TC Memo 2001-263) is a huge tax victory for FLIPs in general. Elma gifted some FLIP interests during her life. She died still owning an interest (the portion not gifted) in the FLIP. The IRS opted for a valuation discount of 15.75% for the lifetime gifts and 13.51% for her estate’s interest in the FLIP.

Now here’s a wonderful fact: The assets in the FLIP were marketable securities (like Exxon and AT&T). The Tax Court awarded a discount of 40% for both gift and estate tax purposes. Ring the victory bells!

One warning: The court made it clear that the valuation issue (translate, “amount of discount allowed”) is fact driven. The quality of the valuation expert you hire (and, if necessary, testifies for you in court) can make or break your sought-after tax results.

Over the years this column has had loads of articles trumpeting the virtues of FLIPs. There are about 20 reasons for doing a FLIP. Here are the top three:

  1. You can give away property (via interests in the FLIP) for gift tax purposes, yet you maintain absolute control for as long as you live.
  2. The huge discounts allowed. Imagine transferring property to a FLIP actually worth $1 million but for tax purposes, it’s only worth $600,000. The $400,000 discount saves you $220,000 in gift and estate taxes.
  3. The assets inside the FLIP are protected from creditors and ex-spouses (for example, one of your kids gets divorced).

You can transfer almost any kind of property to a FLIP (stocks, bonds, real estate, other investments). You would not transfer stock in your S corporation or any qualified plans such as an IRA, 401(k) or profit-sharing plan to a FLIP. There are different strategies to handle these two types of assets.

About 70% of the wealth transfer plans and estate plans we do utilize one or more FLIPs. Look into FLIPs. You’ll be glad you did.

Some IRS no-nos

The IRS is trying hard to show a friendly face. By and large, it has been successful. But when the IRS is on the warpath, stay out of its way.

Vehicle donation programs draw scrutiny. The IRS is worried that many taxpayers unlawfully increase deductions by using the blue book value for those old clunkers instead of actual fair market value. Also, some pitches for these auto-deduction programs promise tax breaks even if you don’t itemize. Don’t believe it. The IRS intends to continue its audit program in this area.

Always check to see that the organization sponsoring the program is a qualified charity. If not, 100% of your donation will be disallowed. Also, you need a professional appraisal if you claim the vehicle is worth $5,000 or more.

Sham trusts. There are dozens of programs — offered at seminars, on the Internet and by referral — that promise you asset protection from creditors and protection from income and/or estate taxes. Most are offshore. If done right, you can accomplish asset protection. Any program also tied to income or estate tax avoidance is a phony. Stay away.

“Secrets” for tax avoidance. It would be difficult to ever give a complete list. The common denominator is usually an “upfront” fee before you are given the secret, usually in the form of a hard-copy written report (or on the Internet). Following is a list of popular too-good-to-be-true tax secrets:

  • Some kind of proof — never real — that taxes are illegal or voluntary.
  • A home-based business, real or imaginary, which allows you to deduct non-business expenses.
  • All Social Security taxes you have paid in will be refunded.
  • Two or more taxpayers get to use the same dependent or both taxpayers enjoy a tax credit or some other tax benefit.

Irving Blackman is a partner in Blackman Kallick Bartelstein, 300 S. Riverside Plaza, Chicago, Ill. 60606; tel. 312/207-1040, or via e-mail at [email protected].

Voice your opinion!

To join the conversation, and become an exclusive member of Contractor, create an account today!