Posts Tagged ‘family limited partnerships’

Beware of Johnny-One-Note estate planning

Saturday, April 4th, 2009

Writing this column is fun.

Even more fun is consulting with column readers to solve their real-life family and tax problems.

When a reader consults with me, I ask him/her to send some basic data, including a copy of their current estate plan. Recently, a small parade of readers have asked me to review — or give a second opinion on — what I call “Johnny-one-note estate planning.”

If your estate plan is done or is in the process of being done, the rest of this item is “must” reading. Estate plans that are built around one main theme (Johnny-one-note) do not play well in the complex world of dozens of concepts available to eliminate the estate tax.

Of the last 31 plans I have reviewed, 26 were based on a single theme. The runaway winner (really a loser in tax-saving effectiveness) is the creation of a revocable trust (RT) — one for him and one for her, where a married couple is involved.

An RT for married folks is a good start to an estate plan, but its only good tax trick is to defer the big estate tax bite until the death of the second spouse.

Two other strategies that I see regularly as Johnny-one-notes are the sale of a business to the kids by the business-owner dad (SALE) and family limited partnerships (FLIPs).

A SALE is often used as a strategy to sell your business to your kids (usually on an installment basis). Never, but never, have I seen a sale of a family-owned business as a tax-effective way to transfer a business to the next generation. Instead, take a look at an intentionally defective trust (IDT), which is the best way to transfer a business tax-free from Dad/Mom to the business kids.

A FLIP is usually not an effective way to deal with a business, a residence, or money in an IRA, profit-sharing plan or similar plan. But it’s a wonderful tax-saving starting point for almost every other asset you might own (stocks, bonds, real estate, you name it.) Properly used, you can 97-26(2) control the assets for life, protect them from the claims of creditors, and reduce their value for estate tax purposes immediately by 30 percent to 40 percent.

For example, say your transfer $1.5 million of investment assets (stocks, bonds, real estate) to a FLIP. For estate tax purposes, the assets are only worth about $1 million, resulting in estate tax savings of about $250,000.

This column over the years has covered RTs, IDTs and FLIPs in detail.

One way you can tell if your estate plan is really properly done is by looking at the estate tax liability if you and your spouse get hit by that proverbial truck.

Whether the liability is $500,000, $5 million or more, your estate plan needs a second opinion.

Why?

Your target should always be to move all your wealth — intact — to your family (for example, if you’re worth $5 million, then the entire $5 million to your family; $50 million, the entire $50 million, etc.).

Following is a list of the six most common strategies we use to transfer your wealth — intact —and eliminate estate taxes. In parenthesis following each strategy is the type of assets you should own to consider the concept.

(1) Qualified personal residence or QPRT (residence).

(2) IDT (your family business).

(3) Subtrust (junk money and other strategies if you have a total of more than $350,000 in your IRA, profit-sharing or similar plan).

(4) Charitable remainder trust or CRT (appreciated assets, including a family business) Briefly, a CRT eliminates the capital gains tax and estate tax.

(5) FLIP (for all assets not list above, generally income producing investments).

(6) Irrevocable life insurance trust or ILIT (insurance is estate tax free to you and your spouse). Use other assets to pay premiums at little or no tax cost.

(7) Premium financing (allows you to buy insurance without paying premiums in cash).

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Posted in Estate Tax, Planning, Uncategorized | No Comments »

Don’t go overboard with one kind of tax strategy

Saturday, April 4th, 2009

Professionally, my second love is writing this column. My first love is consulting with the people who read it.

Every family I work with is different. So are their businesses, their situations, their problems. In spite of these differences, I’m rarely surprised by anything totally new. But one reader sent me something I had never seen before.

Here’s the story.

After about an hour on the phone discussing an estate plan, son Sam calling at the request of dad Joe agreed to send me some typical information: tax returns, financial statements and a copy of the existing plan. About one week later, a heavy box arrived with a five-inch stack of documents. About four inches worth were nine separate family limited partnerships. They were the same except each partnership owned a different asset: the family business, a residence, investments, etc.

As I thumbed through the papers, I couldn’t help thinking about the drunk who was told, “A shot of whiskey each day is good for you.” The guy who did Joe’s estate plan was clearly drunk on partnerships.

One thing should be made clear: I am an enthusiastic cheerleader for the use of limited partnerships in estate planning. Use ‘em all the time. But this overkill of a single strategy just didn’t do the best possible job.

Using the computations of the adviser, the IRS would get more than $2 million in estate taxes. Another $1.1 million of IRS enrichment was likely because of a gross misuse of the partnership strategy.

What does a family limited partnership accomplish? It allows you as a general partner to totally control the use of any asset transferred to the partnership yet reduce the value of the assets transferred. For example, $1 million of assets transferred to a partnership are usually worth only about $650,000 for tax purposes. That $350,000 discount in a 55 percentestate-tax bracket would reduce your estate-tax burden by $192,500. Not bad!

A familylimited partnership is also a great asset-protection strategy. Creditors can’t get at the assets in the partnership. Neither can divorcing spouses of your kids, who are usually the limited partners.

Used properly, a partnership is almost a perfect tax tool. In general, don’t use them to own the stock of your family business. Nor should one be used for non-income-producing personal assets, like a home or car. It’s a valuable strategy for almost every other asset you might own: publicly traded stocks and bonds, real estate, you name it.

Without covering every detail, we terminated the partnerships that held the family business and two family homes. The business elected S corporation status and was transferred to an intentionally defective trust, and the residences were transferred to qualified personal residence trusts. Those are similar concepts that allow you to heavily discount the value of the assets transferred to them.

We used the liquid assets in two other partnerships to pay the premiums on second-to-die life insurance on Joe and his wife, which was owned by an irrevocable life insurance trust that we created. That trust removes life insurance from the taxable estate of the husband and wife.

When all the smoke clears, Joe and his four children, including Sam, will be enriched $4 million to $7 million more than the original overkill plan, depending on how long Joe and his wife live.

One warning: This is an example of overindulgence in one tax strategy. Although the above descriptions cover the main points of how Joe’s problems were solved., this is not a do-it-yourself kit. There are a number of traps and exceptions. Only proceed with the help of an expert.

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Posted in General Tax Strategies, General Tax Talk, Uncategorized | No Comments »

A smart way to transfer your business

Friday, April 3rd, 2009

This article is about an old IRS letter ruling that is one of my favorites. It might be labeled “The lazy man’s way to plan your business transfer.“

The ruling shows you how to take advantage of some favorable tax law while avoiding pitfalls. Good stuff!

Well, there is one slight problem to using the technique: You must drop dead before your family can enjoy the benefits of Letter Ruling 9116031.

But wait, hold the phone. The ruling has one redeeming quality. Really!

First, the facts: Joe, his wife, Mary, and their children owned all the stock in a family business. Joe died in 1990 and Mary inherited all of his stock.

(Note: Mary’s tax basis — for computing capital gains — is the fair market value (FMV) of the stock on the day Joe died. For example, if the FMV was $1 million and she sold it for $1 million, there would be no capital gains tax.)

The fact that Joe’s tax basis, while he was alive, was $25,000, is immaterial. Mary immediately sold all of her stock back to the corporation.

Here’s the general rule: When you or any member of your family sells stock back to your corporation (called a redemption), the redemption is usually taxed as a dividend — a tax disaster.

But there is a special tax-saving exception for a family member who has owned the stock for 10 years or more: If he/she divests all interest in the company (including any position as an officer or director), the redemption is treated as a sale (gets favorable capital gains treatment, instead of being a dividend).

Since Mary sold all (stock she owned before Joe died and stock she inherited from him) of her interest in the corporation, the purchase by the corporation of her shares was considered a bona fide sale (redemption) and not a dividend — a big tax victory.

When all the smoke cleared, not only had Mary escaped a big dividend income tax bill, but she had succeeded in effectively transferring the business to her children. How? Since the kids now owned all the remaining issued and outstanding stock, they owned 100 percent of the business.

To sum up: Mary walked off with a near-tax-free capital gain, (the price paid to Mary for the stock was a bit more than the exact FMV of the stock inherited from Joe) while the kids walked off with the business.

A fantastic tax result.

Stop and think about your own business succession plan for a moment. Isn’t that the result you want — a fantastic tax-free (for income, gift and estate taxes) result? Yes, you can get that tax-free result every time.

More often than not, succession plans are implemented during life, which means there is a second issue (the first issue is tax-free): control.

The typical business owner wants control of his business for as long as he lives. So, when you sit down with your professional advisors, make sure you accomplish a perfect solution to the two key issues: (1) a tax-free transfer and (2) keeping control for as long as you live.

If any other result is offered (no matter how good or smart it sounds), get a second opinion.

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Posted in Corporate Tax, Estate Tax, Tax Strategies | No Comments »

Don’t flip your lid if you have too many FLIP accounts.

Thursday, March 26th, 2009

Professionally, my second love is writing this column; my first love is consulting with the people who read it.

Every family I work with is different. So are its business, its situations and its problems. Despite these differences, I’m rarely surprised by anything totally new. But one reader sent me something I had never seen before.

Here’s the story. After about an hour on the phone, Sam, calling at the request of his dad, Joe, agreed to send me the typical information: some tax returns and financial statements and a copy of the existing estate plan.

About one week later, a large, heavy box arrived with a 5-inch stack of documents. Most of the documents had to do with nine separate family limited partnerships, or FLIPs. All were identical, except each FLIP owned a different asset, like the family business, a residence or investments.

As I thumbed through the papers, I couldn’t help thinking about the drunk who was told, “A shot of whiskey each day is good for you.” The guy who did Joe’s estate plan was clearly FLIP drunk.

One thing should be made clear: I am an enthusiastic cheerleader for the use of FLIPs in estate planning. I use ‘em all the time. But this overkill of a single strategy just didn’t do the best possible job.

The proof: Using the computations of the adviser, the IRS still would cash in for more than $2 million in estate taxes.

Another $1.1 million of IRS enrichment was likely because of a gross misuse of the FLIP strategy.

What does a FLIP accomplish? It allows you to totally control the use of any asset transferred (a tax-free transfer) to the FLIP as the general partner, yet reduce the value of the bundle of assets transferred for tax purposes.

For example, $1 million of assets transferred to a FLIP is usually worth only about $650,000 for tax purposes. That $350,000 discount in a 55 percent estate tax bracket will reduce your estate tax burden by $192,500. Not bad!

A FLIP also is a great asset-protection strategy. Creditors can’t get at the assets in the FLIP. Neither can divorcing spouses of your kids, who are usually the limited partners.

Used properly, a FLIP is almost a perfect tax tool.

In general, a FLIP should not be used to own the stock of your family business. Nor should it be used for non-income-producing personal as sets, like a residence or auto.

It’s a valuable strategy for almost every other asset you might own — publicly traded stocks and bonds, real estate, you name it.

In short, we terminated the FLIPs that held the family business and two family residences.

The business elected S corporation status and was transferred to an intentionally defective trust (IDT), and the residences were transferred to qualified personal residence trusts (QPRTs). An IDT and a QPRT are similar concepts that allow you to heavily discount the value of the assets transferred to them.

We used the liquid assets in two other FLIPs to pay the premiums on second-to-die life insurance (on Joe and his wife), which was owned by an irrevocable life insurance trust (ILIT) that we created. An ILIT removes life insurance from the taxable estate of the husband and wife.

When all the smoke clears, Joe and his four children, including Sam, will be enriched $4 million to $7 million more than the original overkill FLIP plan (depending on how long Joe and his wife live).

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Posted in Estate Tax, Tax Strategies | No Comments »