Forbes.com has been publishing a series on finance and taxes - here's one about an estate tax worst case scenario: Estate Tax Could Come Back with a Sharp Bite. Author Deborah Jacobs discusses the possibility that we could have a $1 million exemption, combined with the elimination of tax reducing strategies such as Grantor Retained Annuity Trusts (GRATs) and Family Limited Partnerships (FLPs).
I'm at the University of Miami School of Law's Heckerling Institute on Estate Planning this week. Our first speaker, Lou Mezzullo, stated that he thinks Congress will not act this year on restricting planning with Grantor Retained Annuity Trusts (GRATs) and Family Limited Partnerships (FLPs) and Family Limited Liability Companies (FLLCs). Too many other things of importance to tackle.
This is from Steve Akers' recent presentation, Estate Planning in Light of One-Year 'Repeal' of Estate and GST Tax in 2010:
"the Administration proposes to dramatically change the rules regarding valuation discounts (emphasis added). If there is an estate and gift tax reform package adopted next year, it could include that provision. If there is no legislation, there are indications that the IRS will issue regulations under §2704 that would place significant restrictions on valuation discounts on entities that are valued on the basis of their liquidation value (such as family limited partnerships holding marketable securities or other assets other than operating businesses.) Therefore, to have a chance to take advantage of the lower 35% rates in 2010 and to avoid the coming restrictions on valuation discounts, clients should consider make desired gifts and sales as early in the year as possible (Emphasis added).
Since the estate tax is sure to return, I am advising clients for whom a family limited liability company makes sense to form it now, and if possible use their $1 million lifetime gift tax exemption now to take advantage of discounting before it is legislated away.
In addition to providing ease of management and significant asset protection, FLPs and (FLLCs) are still a excellent planning tool for obtaining gift and estate tax discounts (for minority interests and lack of marketability) - provided that the implementation and valuation are done correctly. See this BVWire article on Keller v. U.S., 2009 WL 2601611 (S.D. Tex.) (Aug. 20, 2009).
However, anyone considering a FLP or FLLC for the transfer tax advantages should not delay - the Obama administration has recommended legislation prohibiting such discounts in most cases.
What Can We Learn from Sam and Helen Walton?
by: Larry W. Gibbs
Contemporary estate planning causes a division of an estate and results in an ultimate dissipation of the resource base over a period of years. Is it possible to keep the resource base together to serve the family for many family generations? The Sam and Helen Walton story tells us how we can do so. The King Ranch story provides another illustration of what can be done.
Sam Walton's autobiography was published shortly before his death in April of 1992. Sam Walton writes about building a business and entrepreneurship. He also talks about the building of an estate plan. Most of the information I provide comes from the book. Other information comes from those who knew Mr. Walton or members of his family.Continue Reading...
This is from the latest edition of the GiftLaw eNewsletter:
Note from Greg: Family Limited Partnerships (FLPs) were previously the preferred entity for obtaining discounts on transfers of wealth to younger family members. FLPs have largely been replaced by Family Limited Liability Companies (FLLCs). The writer of the article below often refers to FLPs even though the case involved FLLCs.
Indirect Gifts through FLP Trigger $1 Million Gift Tax
In David E. Heckerman et ux.v.United States; No. 2:08-cv-00211 (27 Jul 2009), the District Court determined that gifts of cash to an FLP together with gifts of FLP interests were indirect gifts valued at fair market value.
On November 28, 2001, David and Susan Heckerman created trusts for each of their two children, then ages five and two. They also created the Heckerman Family LLC and two solely-owned LLCs, Heckerman Investments LLC and Heckerman Real Estate LLC. Heckerman Investments LLC was designed to receive liquid securities and Heckerman Real Estate LLC was designed to hold realty.
On December 28, 2001, David and Susan Heckerman transferred a $2.05 million beach house in Malibu, California to Family LLC, with an immediate quitclaim deed to Real Estate LLC. On January 11, 2002, they transferred $2.85 million in mutual funds to Investments LLC and signed gift documents "effective on January 11, 2002" to transfer the majority of Family LLC units to the children's trusts.
Appraiser Mark Wellington of Private Valuations, Inc. completed an appraisal of the value of Family LLC units gifted to the children's trusts. He determined that the transfers would be subject to a 58% discount for lack of marketability. Therefore, both David and Susan had transferred a gift value of $1,022,000. Using their four annual exclusions (two parents times two children) and two $1 million gift exemptions, there was no gift tax payable.
The IRS audited the return, claimed that the securities transfer was an indirect gift and assessed gift tax of $511,497.56 for each donor. The Heckermans paid the gift tax and filed for a refund.
The IRS contended that under Reg. 25.2511-1(a), "whether the gift is direct or indirect," there is a transfer. Because the transfer to the FLP was completed on the same date as the gift of the units and there was no clear evidence that the transfer of the FLP units was after the funding of the FLP, the IRS claimed that this was an indirect gift. The IRS also claimed a step transaction.
The court supported both positions by the IRS. First, the gifts of FLP interests were apparently not signed until after January 11, 2002, but were "effective as of January 11, 2002." Therefore, the transfer process created an indirect gift on the theory that the children's trusts owned the FLP units when the cash was transferred.
In addition, following the rationale of Senda v. Commissioner, 433 F.3d 1044 (8th Cir. 2006), there was a "step transaction" that also created the indirect gift. Because the transfer of $2.85 million in cash to Investments LLC and the gifts of the LLC units were an "integrated transaction," the step transaction doctrine applied.
Editor's Note: It is significant that the IRS did not object to the FLP discounts for the transfer of the real estate on December 28, 2001 and gift of FLP units two weeks later on Jan. 11, 2002. With even a period of two weeks between the funding and the FLP unit gifts, the transfer was effective in producing a substantial FLP discount.
The U.S. Tax Court decision in Estate of Erma V. Jorgensen, T.C. Memo 2009-66, provides another example of the wrong way to create and administer a family limited partnership from an estate tax planning perspective. See this article by attorney Kay Ford Bailey of Austin, Texas for a brief analysis.
In the recent case of Estate of Valeria M. Miller v. Commissioner; T.C. Memo. 2009-119; No. 5207-07 (27 May 2009), the U.S. Tax Court allowed a 35% discount for gifts of family limited partnership interests. No discount was permitted for the FLP interest owned by the decedent at her death.
This case shows that a properly planned and executed family limited partnership or limited liability company is still a very effective way to pass on wealth to younger generations. However, Obama's tax proposals would do away with such discounts in most cases.
Click here for a summary and the full text of the case, thanks to NC State's GiftLaw eNewsletter.
The U.S. Tax Court issued an opinion on January 29, 2009 in the Estate of Marjorie deGreeff Litchfield v. Commissioner (T.C. Memo. 2009-21). The case involved the determination of appropriate (estate tax) discounts for built-in capital gains tax liabilities, and lack of control and lack of marketability for minority interests in two closely held family corporations, including one that had recently converted to a subchapter S corporation. The court allowed a discount of 91% for the built-in capital gains tax for the C corporation, and 52% for the S corporation. The minority interest (lack of control) discount was determined to be 14.8% for the C corporation and 11.9% for the S corporation. The lack of marketability discounts were established at 25% and 20%, respectively, for the two entities. The FMV Valuation Alert offers a nice summary.
This case involved farmland and marketable securities. Discounts for transfers of entities owning marketable securities and cash will be history if HR 436, the Certain Estate Tax Relief Act of 2009, passes.
The estate tax exemption is up (to $3.5 million) and portfolios are down. However, for those whose estates are still above $3,500,000, now is the perfect time to transfer wealth to younger generations. Interest rates are low, and the tax laws may never be more favorable. See Tough Times Are Good Times to Trim Estates on the WSJ website.
What is an LLC?
In 1977 Wyoming was the first state to enact laws permitting the creation of a Limited Liability Company. An LLC combines the best features of a corporation with the best features of a partnership. Among other things, an LLC has the limited liability of a corporation and the ease of management and flow-through income tax treatment of a partnership.
In 2000, Wyoming again led the nation by enacting its Close LLC statute. This type of LLC is designed specifically for a small closely held family business. Family assets (such as stocks, bonds, farms, ranches, rental property, CDs and family businesses) can be managed under the protective umbrella of a Wyoming Close LLC.Continue Reading...
As a proponent of Family Limited Liability Companies (LLCs) for asset management, creditor protection, and ease of gifting, I was pleased to read about the U.S. Tax Court's decision in Mirowski v. Commissioner, T.C. Memo 2008-74. March 26, 2008.
Mrs. Mirowski, widow of the inventor of the heart defibrillator implant, created a trust for each of her three daughters in 1992, which were funded with portions of her interests in the patent licenses. Then, in 2001, she formed a single member LLC, transferring substantial assets to it. Shortly thereafter, Mrs. Mirowski gifted a 16% interest in the LLC to each of the trusts. A mere four days later, she died unexpectedly.
The IRS argued under Section 2036(a) of the Internal Revenue Code that Mrs. Mirowski retained the right to income or enjoyment of the gifted property, so that it was included in her taxable estate. The estate maintained that the Section 2038 "bona fide sale" exception applied, so that the transferred assets were not subject to estate tax.
The Tax Court agreed, holding that the LLC's activities do not have to be equivalent to those of a "business" for the bona fide sale exception to be applicable. The Court stated that Mrs. Mirowski had "legitimate and significant non-tax reasons" for establishing and funding the LLC, including 1) joint management of family assets, 2) combining family assets to maximize investment opportunities, and 3) enabling equal transfers to her daughters.
Some key points for Family LLCs to hold up for gift and estate tax purposes:
- Strictly follow the terms of the Operating Agreement
- State the reasons for the LLC in the Operating Agreement
- Have the Agreement reviewed by separate counsel for all initial members
- Leave enough assets outside the LLC to live on and pay taxes
- Don't mingle LLC assets with personal assets
- File the proper tax returns each year
- File the necessary documents with the Secretary of State each year
- Don't put your personal residence in a Family LLC
- Make sure the senior generation does not have the power to allocate profits and losses
- Require annual distributions
- Have the junior family members (or their trusts) make initial contributions to the LLC to provide for the pooling of assets
- Don't wait until the senior family member is near death
The bottom line is that Family LLCs remain a viable and attractive option for transfers of family wealth, while also providing asset protection and management advantages. Just make sure you use an attorney experienced in forming Family LLCs to assist you, and carefully follow all of his or her instructions.
Family Limited Partnerships, or more commonly now, Family Limited Liability Companies, are great vehicles for management and protection of family businesses, real estate, and investments. They also can be used to facilitate gifting, since interests in the entity given to junior family members typically qualify for minority interest and lack of marketability discounts. These discounts can provide powerful leveraging.
However, to stand up to IRS scrutiny, it is important the FLP or FLLC be properly formed and administered. Click "Continue Reading" for a checklist to help determine if your family entity meets the necessary criteria.