Liberalization of the gift and estate tax is imminent, so careful planning will be key during the years to come. You may want to consider establishing a Family Limited Partnership to facilitate the transfer of wealth to younger generations in a low or no tax environment.
The gift and estate tax is a tax up to 55% on individuals who during their lifetime gift, or upon death bequeath, more than $675,000. A married couple can transfer $1.35 million without paying any gift or estate taxes. Proponents of the estate tax believe that the tax plays a critical role to raise revenue for social programs, encourage charitable giving, and redistribute wealth from the top of the economic ladder to the rest of society.
President elect Bush has expressed his dislike of the gift and estate tax over the last several months. With a slim republican majority joined by many conservative Democrats in the House, the level which assets are currently transferred without any estate tax will almost certainly be raised (beyond the current scheduled increases) and the tax may be repealed altogether. You may want to take advantage of this window of opportunity to give assets to younger generations. The estate tax changes I expect in the near future may subsequently be reversed and the window may close again.
Video Games and Twizzlers
Maybe you want to pass wealth to your heirs, but you don’t think that it is healthy for Junior to get a big check right now. Although Junior is a real great kid, you still remember when he spent his entire allowance on video games and Twizzlers. What if I told you that you could give a bunch of cash or other assets to Junior, still maintain control in the management of that money, and potentially save millions in gift and estate taxes? All this and more are possible with a Family Limited Partnership or FLP.
A FLP is an entity, composed of general and limited partners that is set up to pool and manage family assets, such as real estate, family businesses, and securities. You can be the owner and president of a corporation that is the general partner. This allows you to control and manage partnership assets, make all the investment decisions, and give limited partnership interests to Junior. There are several additional benefits of using a FLP to facilitate the passing of wealth to younger generations. FLPs protect family wealth from leaving your family in the event your children, when grown, experience divorce, financial difficulties, legal issues or other personal problems. If the partnership agreement is written properly, limited partnership interests can be insulated from the potential claims of creditors. Also, FLPs can be an effective vehicle for introducing children to the management of family wealth as they mature. FLPs are often more flexible than other estate planning tools, such as trusts. An advantage of gifting assets, such as marketable securities, during your lifetime is that the assets are able to grow outside of your estate, saving tremendous amounts in gift and estate taxes.
Valuation Discounts May Reduce Tax
A big reason why FLPs are currently very popular is the possibility of gifting limited partnership interests at a significant valuation discount, thus greatly reducing gift and estate taxes. Here is how it works. Would you, a willing buyer, pay the fair market value for an asset like a 2001 Harley Davidson, if you had no rights to ride it or to sell it? You would only be willing to pay an amount less than the fair market value because your ownership rights are restricted. As in the gift of the Harley Davidson, valuation discounts may be warranted when gifts of limited partnership interests to limited partners have certain restrictions of ownership. If a limited partner does not have control over the underlying assets and does not have the right to sell either the assets or the partnership interest itself, the value of those items may be discounted. However, I would not suggest setting up a FLP for the sole purpose of obtaining a valuation discount for gift and estate taxes. Although the IRS has generally not been successful in contesting the discounts in the past, the discounts may not hold up in the future.
It is important to try to anticipate changes in the law so that you can plan accordingly. The upcoming years may be a great opportunity for transferring wealth to younger generations. Some financial planners believe that a phase-out of the estate tax will decrease the need for estate planning and establishing FLPs. I disagree. If you are interested in the many benefits of FLPs and you don’t think that the best thing for Junior is to just write him a big check, then I think you should consider a FLP.
