In the face of a government whose appetite for revenue appears insatiable, and a federal estate tax that is already 50%, estate planning is becoming more important to a larger number of families around the country. It is important if the parents wish to see their savings passed to their children. To the country as a whole, estate planning has become increasingly important because personal savings is an important part of our capital base. Capital is the fuel that makes our economic engine run. Without adequate capital, there can be no job creation or increase in living standards.

In the United States, the estate tax law is written to discourage savings. The government is telling us to spend our money, or give it away. If you die with anything substantial, the IRS is going to take half of it. Because of this, capital remains very expensive and businesses can not afford to invest in equipment that will allow it to raise the living standards of its employees.

 

Large estates are an easy target. Congress knows they can look to high income individuals as a revenue source without causing much political damage. But, its the middle class who suffers the most when the wealthy are taxed. High income individuals are more likely to adjust to the decrease in their income caused by the tax increase, by reducing their savings rather than changing their life style. The result is a decline in personal saving that has a direct impact on long term interest rates.

 

A good example of this is President Clinton's 1993 budget bill. After the tax increase on high income individuals went into effect, the personal saving rate in this country decreased from 5.8% to 5.5%. During that same period, long term interest rates have increased from 5.75% to 7.5%. The inevitable result is sharply higher housing costs and car payments for the middle and lower class family. At the same time, the increase in the cost of capital to business slows the growth in productivity. Lower growth in productivity will eventually slow the growth of personal income.

Proper estate planning not only serves the client (by passing a persons assets to his or her heirs) but, increases his incentive to save, and has a positive impact on the economy of the whole country, by encouraging lower long term interest rates.

 

Currently, one of the most versatile and effective tools available to the estate planner is the family limited partnership. It was one of the tools used by Sam Walton to pass his estate—an estate worth $23 billion—essentially tax-free. The family limited partnership is useful for any estate with assets of $2 million or more for a couple, or $1 million for a single individual. This partnership, when properly structured, will accomplish three important goals for any person with substantial assets:

1. A vehicle for protection of assets from creditors
2. discounts for the value of assets when calculating estate and gift taxes
3. income tax reduction.

The key to lowering estate taxes is not owning very much when you die. It is important to understand the difference between ownership and control. While it is easy to think of these two powers as inseparable, they are not. As the owner of 100 shares of stock in a Fortune 500 Corporation, you are indeed the owner of a piece of that business but, you have no control over the assets of the business. On the other hand, the CEO of that corporation may not own a single share of the company's stock but, he has a great deal of control the assets of the business. He can direct that checks be written on any of the company's bank accounts. He can buy or sell real estate, or any other asset, in the company's name. He can fly his wife and German Shepherd to Hawaii for the weekend on the company jet without encumbering his personal income tax liability. The CEO can decide who uses the assets and for what purpose. The chief executive has the power to spend the revenues of the business in whatever manner he feels is in the best interest of the company.

 

The family limited partnership allows the client to separate ownership from control—or more precisely to pass ownership but retain control. The partnership is a separate entity, established by the senior generation of a family. It has one general partner, and as many limited partners, as there are family members. It is recommended that the general partner be a corporation. vide planning flexibility that will aid with both asset protection and tax savings. The typical partnership will look like figure one when first established.

 

Ownership of the corporate general partner may include the children. Particularly if asset protection is important to the client. If the husband and wife together own less than 50% of the corporate general partner, a person with a judgment against either cannot have the corporation liquidated. This means that creditors do not have access to any asset in the partnership to satisfy the judgment. If the founders do not retain a majority interest in the stock of the general partnership, a shareholder agreement can be written. In this agreement you can specify that the husband and wife will have complete control of the corporation until they die. As an alternative, different classes of stock may be used with the corporate general partnership to separate ownership from control.

Partner	Assets	Units
Wife	$2,475,000	24,750
Husband	$2,475,000	24,750
Corporate	$50,000	500

 

This particular business form (limited partnership with corporate general partner) has evolved over a number of years. It has been developed to provide a vehicle that combines the limited liability of a corporation with the tax planning advantages available to a partnership. For simplicity, let us ssume that the husband and wife place assets with the value of $5,000,000 in the family limited partnership, and that the partnership consists of 50,000 units. The ownership of the limited partnership would break down as shown on Table One.

 

The husband and wife would now be able to transfer partnership units to their children or to anyone whom they wish. The main tax advantage of this form is that the units are not worth as much as the individual assets of the partnership they represent. The IRS recognizes several discounts that apply to these interests. These discounts arise from the fact that units do not bring with them control over the assets. No third party will pay full asset value for the unit because he is not receiving actual assets—just a piece of paper indicating the right to a proportionate share of the assets if the general partner ever decides to liquidate the partnership. During the life of the partnership, the only right the limited partner has is to receive his share of any distribution that the general partner decides is appropriate.

 

There are three particular discounts that the IRS will recognize: a discount for lack of marketability; for lack of control; and for a minority interest. To establish these discounts, an appraisal must be done by a qualified professional appraiser. There may be a good deal of variation depending on the character of the individual assets, generally the appraiser will find the appropriate discount is between 30% and 50%.

In the following example let us assume that an appraisal is done, and the appraiser establishes that the proper discount is 40%. This discount applies to the partnership interest whether they are transferred by gift or passed through an estate. In this example, upon the death of the first spouse there is no tax if the units are left to the surviving spouse. With the death of the second spouse, the taxes due are shown in table two.

 

This assumes that proper planning has been done to preserve the full Unified Credit for both the husband and the wife. The parents can begin to pass their partnership interests to their children by using the annual $20,000 gift exemption. The face value of the units is $100 based on the value of the assets that were placed in the partnership when it was formed. With the discount, the value of the units for gift tax purposes is $60. Therefore, the husband and wife can give 333 units to each child per year, instead of 200 without the discount. These units represent assets with a face value of $33,000.

 

Depending upon the parent’s situation they may also want to make an immediate gift to use up their Unified Credit. They can transfer units worth up to $1,200,000. This can be an important step if the assets in the partnership are likely to appreciate. A present transfer will in effect freeze the value of all assets transferred. They will not be included in the estate of either spouse. All appreciation after the date of the transfer will be taxed only at the child's level. In the example above, each parent could give 10,000 units without having to pay any gift tax. Assets most likely to appreciate are real estate, common stock, and interest in a family business. If a large portion of the partnerships' assets are invested in these types of investments and the parents are in their mid-sixties or younger, then an immediate gift can be very beneficial. For example, let us assume that the assets appreciate at the 100-year average rate for the Standard and Poor's 500 average.

	Without	With
Taxable Estate	$20,000,000	$1,925,280
Net Tax	$10,980,280	$738,670
Tax Savings		$9,855,730

The example in table three assumes that the second spouse dies after 22 years and the first spouse died six months earlier. It assumes that both parents gave the maximum gift each year that would qualify for the annual gift tax exclusion, and that all appreciation was uniform over the twenty-two year period. Under these circumstances, the total tax savings from the family limited partnership is $9,855,730. The function of the corporate general partner is to manage the assets and affairs of the family limited partnership. In return, the corporation receives income from the partnership in the form of management fees. With this income, the corporation can pay salaries and brackets, and use pre-tax dollars to fund benefit, and retirement plans. While the benefits of this kind of planning are great, it is not for everyone. First of all, there has to be substantial assets. The drafting of the partnership agreement and benefits to family members that are employees. Family members must be employed in some real function. When this is done correctly the partnership can be used to shift income to individuals in lower tax related documents should be done by an attorney who is experienced in Family Limited partnerships. It is extremely important that Partnership be established and administered correctly. There are additional tax forms to be filed every year and paper work that is required to support the various entities involved. If any of these things is not done correctly, you are faced with the loss of the tax benefits.

 

Mr. Losch is an attorney practicing in Orlando Florida. He is also the president of Losch Management Company Inc. A company that offers portfolio management and small business consulting services. Mr. Losch may be contacted at Losch Management Company 9004 Gladin Court Orlando FL 32819