Business owners have several options to consider when planning to transfer their assets. Because estate taxes can be prohibitive, you need to investigate approaches that will maximize the potential savings while still providing you with some degree of control over, or continuing cash flow from, the asset being transferred.
By now you’re probably well aware of the estate tax changes that began in 2001. And your first thought might have been, “Hooray! I don’t have to worry about estate planning anymore.” But the repeal phases in slowly over the next several years. And because of a “sunset” provision, in 2011 the estate tax will return unless Congress passes further legislation.
In addition, current law includes other provisions that increase the complexity of estate planning, such as gradual repeal of the generation-skipping transfer (GST) tax; reduction in the top gift tax rate but no repeal of the gift tax; increases in gift, GST and estate tax exemptions; and repeal of the step-up in basis at death.
Finally, you can exclude most gifts of up to $11,000 per recipient each year ($22,000 per recipient if your spouse elects to split the gift with you).
As a result, estate planning is more important than ever — without proper planning, your family could still lose to estate taxes a large share of what you’ve spent a lifetime building.
Family Limited Partnership
Are you looking for a way to save estate taxes and leverage your use of gift tax exemptions while protecting and maintaining control over the assets you are giving away? If so, a family limited partnership (FLP) may be the perfect estate planning strategy for you.
For decades, taxpayers fought with the IRS in the courts over the concept of minority and marketability discounts in a family setting. Taxpayers were often successful in these disputes, but a great deal of uncertainty remained about such discounts.
Then, in 1993, the IRS finally conceded the battle and agreed that gift tax valuation discounts should apply in family situations.Ever since, the FLP has enjoyed great popularity. The IRS continues to fight FLPs every step of the way, however, particularly if they’re not structured or operated properly. And it’s highly likely that these discounts will eventually be curtailed or even eliminated.
The key to enjoying discounts is to use a vehicle, such as an FLP, that doesn’t give the recipients control over the investment they end up owning. Of course, the discount’s amount must be determined, ideally by a formal valuation, and will vary depending on the partnership agreement and the nature of the assets transferred to it. Discounts generally range from 20% to 40%.
In the typical FLP, the parents or grandparents making the gift become the general partners, while children and/or grandchildren become limited partners. The latter have neither control over the partnership’s management or assets nor any personal liability beyond their interest in the partnership itself. Either all at once (using the gift tax lifetime exemption and perhaps even paying gift tax beyond that point), or over a period of years (using the gift tax annual exclusions), the parents may gift as much as 99% of the partnership to younger generations.
Various assets can be transferred to an FLP, including marketable securities, real estate or interests in closely held businesses. The partnership may become an owner in other partnerships, limited liability companies or C corporations (but still not S corporations).
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