Provided by the Law Offices of RICHARD
MAYBERRY
MAYBERRY LAW FIRM
2010 Corporate Ridge
McLean, VA 22102
(703)714-1554
Committed to providing the highest quality estate planning legal
services for individuals, families and businesses |
A Family Limited Partner-ship (FLP or FLIP) is not only a
popular business entity for wealth management, but also is a powerful
vehicle for wealth transfer planning. Under the right circumstances a FLIP
can help you remain in control of your wealth even after you transfer it
to your loved ones. Additionally, these transfers may be made at a
discount, thereby leveraging your transfer tax savings. Not surprisingly,
while FLIPs may be seen as a planning panacea by taxpayers, they are
viewed as an anathema by the IRS.
Background
Simply put, a FLIP is a Limited Partnership among
family members. The FLIP is often created by the wealth-owning generation,
typically the parents. The FLIP creators are initially both the General
Partners (GPs) and the Limited Partners (LPs) at the time they contribute
assets to the FLIP. The lion’s share of the contributed assets are
assigned to the LP shares. Even so, the GPs hold all of the management
control over the FLIP assets. When the FLIP assets generate income, the
GPs are entitled to compensation for their management services. LPs enjoy
an ownership interest only. They have few rights or power and there are
restrictions on the transferability of their LP interests. This lack of
control (minority interest) and inability to transfer the LP interests freely
(lack of marketability) reduces or discounts the value of
the FLIP assets. In turn, this discounting enables the parents to transfer
more wealth (and the future appreciation of that wealth) via their LP
interests to younger family members, yet retain lifetime control over that
wealth. Other benefits include income splitting and asset protection.
Income Splitting
Many parents are in higher income tax brackets
than their children. As a pass-through entity
by definition, a FLIP provides a legal conduit to flow a proportional
share of income and deductions among these LPs with lower tax brackets.
The income tax savings alone may be substantial, keeping more wealth in
the family and away from the IRS.
Asset Protection
Every parent fears the potential divorces,
lawsuits, bankruptcies and financial irresponsibility of their children.
These are excellent reasons not to make lifetime wealth transfers to them.
Nevertheless, a FLIP may be a perfect solution. Because the
transferability of an LP interest is limited, a creditor of the LP has no
more rights than the LP. This inability to directly reach the underlying
FLIP assets makes an LP interest less attractive. Should a creditor
prevail in court against the LP, it likely will receive a charging order from the judge to
receive the LP’s interest from the FLIP. However, if the FLIP generates
income that is not actually distributed by the GP to the debtor LP, then
the creditor could incur an income tax liability without an actual cash
distribution to pay it!
IRS Attacks
Given the powerful tax benefits available through
FLIPs, it is easy to see why the IRS just doesn’t like them. First and
foremost, the FLIP must be created for a business purpose…not just for
estate planning. For example, a valid business purpose may be to
“maintain family ownership and control of assets while they are
transferred between generations free from the claims of third-party
creditors and probate.” As you might imagine, in addition to the
FLIP’s business purpose, the IRS scrutinizes the valuation discounts claimed by the taxpayer
for the LP interests. Once these gifts are made, ensure that any
discounted values claimed are justified by a valuation expert and that
they are reported on a timely gift tax return. Doing so will trigger a
three-year statute of limitations for the IRS to audit the return. Expert
professional valuation assistance is critical to successful FLIP planning,
implementation and maintenance. It is money well-spent.
Practical
Consideration
FLIPs are not for everyone. Between legal
fees, valuation fees, required state filings and reports, and tax returns
(for the FLIP, the GPs and the LPs), a FLIP may require a substantial
commitment in time and resources. Also, there is no step-up in basis for
the FLIP assets upon the death of a GP.
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