Why a FLP Strategy in 2020 Could Benefit Your High-Net-Worth Clients
Harry met Wilma and started a family. Now, they’re looking for a valuable wealth preservation or asset protection instrument for their $100 million estate. Family Limited Partnerships (FLPs) have been and continue to be one of the most powerful tools in an estate planner’s toolbox due to the ability to significantly discount the value of gifts made from parents to the next generation(s). Utilizing the doubled lifetime exemption afforded by the Tax Cuts and Jobs Act ($11.4 million/single, $22.8 million/married), a parent may be able to use a FLP strategy to gift heirs more assets from their estate than what they’d otherwise be able to directly gift, while also maintaining some control over those same assets.
To help you better understand FLPs and the value they provide, Harry and Wilma’s opportunity is demonstrated in the following hypothetical example:
Harry & Wilma’s Opportunity
Harry and Wilma have a total net worth of $100 million and are looking for ways to:
- Reduce their estate
- Benefit their two children, Steve and Darla
- Retain control over the management of their assets
Under current law and assuming no prior gifting, Harry and Wilma currently have $22.8 million in available estate and gift tax lifetime exemption.
If they were to gift their children $29,400,000 directly, without the use of the FLP strategy, they would report a gift of $29,400,000. Because this amount exceeds the couple’s current lifetime exemption amount of $22,800,000, they would immediately owe gift taxes in the amount of $2,616,000.
Instead, Harry and Wilma determined they want to form a FLP and fund it with $30 million of income-producing commercial real estate. Through the FLP, they then gift their two children 98% (49% each) in the form of limited partnership interests which, at first glance, would appear to have a value of $29,400,000. Harry and Wilma keep the remaining 2% ($600,000) for themselves in the form of a general partnership interest.
Because Harry and Wilma chose to use a FLP, they can discount the gift to their children by 30%. The amount of gift reported on Harry and Wilma’s gift tax return utilizing the FLP strategy is $20,520,000, rather than the full $29,400,000 (see calculation below).
Gift to Steve: $10,260,000 [((49% x $30,000,000) x 0.7) – $30,000]
Gift to Darla: $10,260,000 [((49% x $30,000,000) x 0.7) – $30,000]
Because the reported gift to Steve and Darla is below their current lifetime exemption amount of $22,800,000, Harry and Wilma will owe no gift taxes by making this transfer. The sole consequence of the gift is a reduction of the couple’s lifetime exemption by the amount of the reportable gift—in this case, $20,520,000—thus leaving Harry and Wilma $2,280,000 of lifetime estate/gift tax exclusion to use with other estate planning techniques.
By utilizing this technique, Harry and Wilma removed $29,400,000 from their estate, paid no gift taxes (saving them $2,616,000), and were only required to report gifts equal to $20,520,000.
The Ins and Outs of FLPS
After seeing the power of the FLP strategy in the above hypothetical example, you may be interested in using this technique to help your clients. Here’s how it works:
To establish a FLP, you or your clients who are parents or grandparents must contact an attorney to draft a FLP formed under state law. The partnership agreement deals with two classes of interests, and spells out the rights of each partnership interest:
- the general partner
- the limited partner
The FLP limits the ownership to only those whom the parents deem acceptable. At the same time, it provides the partnership with the right-of-first-refusal if partners divorce or if offered to be sold to a third party.
At inception, the parents own all the interests of the FLP. Once funded, the parents transfer limited partnership interests in the FLP to their children or grandchildren while reserving the general partnership interests for themselves. The general partnership interests kept by the parents include the same rights as limited partnership interest, but also include the ability to manage and control the property held within the FLP. Limited Partnership interests given to the children or grandchildren give them a proportional distribution right to both income and liquidation proceeds.
When the parents gift the limited partnership interests to their children/grandchildren, they are required to report such gifts on their gift tax return (IRS Form 709). Happily, the IRS currently allows the parents (donors) to discount the value of gifts of limited partnership interests, using up to two generally available discounts:
- Lack of marketability, and/or
- Minority interest.
The percentage discount acceptable to the IRS is facts- and circumstances-dependent and can range anywhere from 20%-50%, varying by client.
The Opportunity That Exists Today
If this strategy interests you, or you think you may have a client who could benefit from a FLP, there is one more thing to note. Changes can come with any election, and as the 2020 election approaches, FLPs may change, too. Establishing a FLP before any modifications might occur means an FLP in its current working state could and would likely be grandfathered. Therefore, if you’re interested in this strategy, speak with your high-net-worth clients sooner rather than later about utilizing an FLP strategy.
To learn more contact your Highland Vice President or the Highland Advanced Planning team at firstname.lastname@example.org.