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).
