The senior generation tranfers cash and
asset to the Family Limited Partnership (FLP) in exchange for both general and limited partnership
interests. The senior generation then transfers limited partnership interests to their children and
grandshildren.
The FLP purchases a life insurance policy on
the life of a general partner and is the owner and beneficiary of this policy. At the insured's death, the
FLP receives the proceeds generally income tax free, and either lends the money to, or purchases assets
from, the insured's estate.
The executor of the insured's estate may
use the money he receives from the FLP to help pay estate taxes and administration costs.
Heirs receive the net assets of the estate,
including partnership interests.
In order to secure a source of liquidity to help pay estate taxes and
other obligations, taxpayers often establish an Irrevocable Life Insurance Trust (ILIT) to purchase
and own a life insurance policy on the taxpayer's life. Upon the taxpayer's death, policy death benefits
are paid to the ILIT with which the ILIT may either purchase assets from, or make loans to, the insurer's estate.
The life insurance death benefit proceeds can remain out of the insured's estate only by eliminating
his "incidents of ownership" over the policy. Accordingly, the insured typically will not be named as trustee, leaving
him without control over the policy, or access to the cash value. Further, the ILIT must be made irrevokable so that
the insured is not deemed to retain control over, and therefore incidents of ownership in, the policy.
This of course, limits the taxpayer's flexibility in that, once established, the
taxpayer may not revoke or amend the ILIT without a formal court order.
Many planners see the Family Limited Partnership (FLP) as a more flexible
alternative to the Irrevocable Life Insurance Trust. Among other benefits, the FLP offers these advantages
over the ILIT:
The terms of the partnership may be amended upon the agreement of the partners.
Where the insured is the general partner, he has management control over partnership
assets, including the policy on his life, for partnership purposes.
Where policy proceeds are paid solely to the partnership, the insured should not have
the entire policy proceeds included in his estate.
The insured's gross estate will be increased by the life insurance proceeds only to the
extent that they are attributable to, and increase proportionately, the value of his partnership interest.
The senior generation members -- typically parents or grandparents -- make a
nontaxable transfer of assets to the partnership in exchange for both general and limited partnership
interests. Each parent retains a one percent general partnership interest and a 49 percent limited
partnership interest.
The partnership may then purchase a life insurance policy on the life of one or
on the life of both of the general partners, naming the partnership as the sole beneficiary. The parents begin
gifting limited partnership interests to their children and grandchildren, thereby reducing their interest in
the partnership and its assets. The parent may, over time, and through utilization of their unified credits,
gift away all of the limited partnership interests, effectively reducing their interest in the partnership.
At death, policy proceeds are paid to the partnership, with which it may purchase assets from, or make loans to,
the decedent's estate.
Unlike an ILIT, the FLP may be amended upon the agreement of the partners.
If the insured is the general partner, he/she has management control over the
partnership assets, including the life insurance policy on his/her life(s), for partnership purposes.
If the death benefit proceeds are payable soley to the partnership, the insured should
only have a proportional amount of polcy proceeds included in his/her estate equal to his/her ownership interest
in the partnership.
The FLP provides a flexible alternative to an ILIT for purposes of minimizing
inclusion of a policy in the insured's estate.
Gifts of the limited partnership interests are not likely to qualify for the
annual exclusion from gift tax. The senior generation must use their unified tax credits to gift
their partnership interests to their children and grandchildren.
The insured's gross estate will be increased by the proportion of the life insurance
proceeds attributable to his/her partnership interest.
While most tax advisors would agree FLP can be used to transfer assets to family
members at a discount, care must be taken to obtain a discount. In 2000, the IRS issued a Field Service
Advice (FSA), advising its District Counsel on differing theories they could use to attack FLP discounts.
Establishing and administering a FLP is, however, a costly endeavor. The individual must
employ valuation experts to value the underlying property, as well as to determine the appropriate discounts
for the lack of control and lack of marketability; attorneys to prepare the partnership agreement; and
accountants to prepare annual tax returns. The cost of establising and administering a FLP may outweigh
the benefits of the FLP if an individual does not have a substantial amount of property to contribute to
a FLP.
