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Flip- Flap
A Family Limited Partner-ship (FLP or FLIP) is not only a popular business
entity for wealth management, but also is a powerful vehicle for wealth
transfer planning. Under the right circumstances a FLIP can help you
remain in control of your wealth even after you transfer it to your loved
ones. Additionally, these transfers may be made at a discount, thereby
leveraging your transfer tax savings. Not surprisingly, while FLIPs may be
seen as a planning panacea by taxpayers, they are viewed as an anathema by
the IRS.
Background
Simply put, a FLIP is a Limited Partnership among
family members. The FLIP is often created by the wealth-owning generation,
typically the parents. The FLIP creators are initially both the General
Partners (GPs) and the Limited Partners (LPs) at the time they contribute
assets to the FLIP. The lion’s share of the contributed assets are
assigned to the LP shares. Even so, the GPs hold all of the management
control over the FLIP assets. When the FLIP assets generate income, the
GPs are entitled to compensation for their management services. LPs enjoy
an ownership interest only. They have few rights or power and there are
restrictions on the transferability of their LP interests. This lack of
control (minority
interest) and inability to transfer the LP interests freely (lack
of marketability) reduces or discounts the value of the FLIP
assets. In turn, this discounting enables the parents to transfer more
wealth (and the future appreciation of that wealth) via their LP interests
to younger family members, yet retain lifetime control over that wealth.
Other benefits include income splitting and asset protection.
Income Splitting
Many
parents are in higher income tax brackets than their children. As a pass-through
entity by definition, a FLIP provides a legal conduit to flow a
proportional share of income and deductions among these LPs with lower tax
brackets. The income tax savings alone may be substantial, keeping more
wealth in the family and away from the IRS.
Asset Protection
Every
parent fears the potential divorces, lawsuits, bankruptcies and financial
irresponsibility of their children. These are excellent reasons not to
make lifetime wealth transfers to them. Nevertheless, a FLIP may be a
perfect solution. Because the transferability of an LP interest is
limited, a creditor of the LP has no more rights than the LP. This
inability to directly reach the underlying FLIP assets makes an LP
interest less attractive. Should a creditor prevail in court against the
LP, it likely will receive a charging
order from the judge to receive the LP’s interest from the FLIP.
However, if the FLIP generates income that is not actually distributed by
the GP to the debtor LP, then the creditor could incur an income tax
liability without an actual cash distribution to pay it!
IRS Attacks
Given the powerful tax benefits available through
FLIPs, it is easy to see why the IRS just doesn’t like them. First and
foremost, the FLIP must be created for a business purpose…not just for
estate planning. For example, a valid business purpose may be to
“maintain family ownership and control of assets while they are
transferred between generations free from the claims of third-party
creditors and probate.” As you might imagine, in addition to the
FLIP’s business purpose, the IRS scrutinizes the valuation
discounts claimed by the taxpayer for the LP interests. Once these
gifts are made, ensure that any discounted values claimed are justified by
a valuation expert and that they are reported on a timely gift tax return.
Doing so will trigger a three-year statute of limitations for the IRS to
audit the return. Expert professional valuation assistance is critical to
successful FLIP planning, implementation and maintenance. It is money
well-spent.
Practical Consideration
FLIPs
are not for everyone. Between legal fees, valuation fees, required state
filings and reports, and tax returns (for the FLIP, the GPs and the LPs),
a FLIP may require a substantial commitment in time and resources. Also,
there is no step-up in basis for the FLIP assets upon the death of a GP.
Copyright © 2005 Integrity Marketing Solutions. All rights reserved.
Some artwork provided under license agreement. This publication does not
constitute legal, accounting or other professional advice. Although it is
intended to be accurate, neither the publisher nor any other party assumes
liability for loss or damage due to reliance on this material.
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