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THE ADVANTAGES AND DISADVANTAGES OF FAMILY LIMITED PARTNERSHIPS

The family limited partnership (FLP) is a very popular estate planning tool. The FLP is similar to a regular limited partnership, but typically holds the income-producing assets of a single family. It can be used to pass a family business or rental properties to children or grandchildren without triggering probate and estate taxes. But in addition to tax avoidance, a FLP offers a host of other benefits as well.

A "Tax Avoidance" Strategy
In its simplest form, a FLP is created in two steps. First, parents transfer property to a newly-formed partnership in exchange for both the general and limited partnership interests. This effectively converts property interest ownership into partnership interest ownership. Next, limited partnership interests are gifted to family members using the Lifetime Gift Exclusion Credit of up to $1.2 million per child. Subsequently, parents are able to make further annual gifts of limited partnership interests to their children under the annual gift tax exclusion. Parents are thereby able to transfer substantial amounts of accumulated wealth without estate or gift tax consequences.

Gifts are Subject to Discounts: Another Tax Saving
Limited partnership interests are valued at a discount when transferred to family members. The rate of discount reflects the generally unattractive nature of the interest to the public investment community. Limited partners may not participate in control of the business. Further, FLPs usually contain restrictions on transfer and dissolution which effectively "lock in" minority interests. Since potential investors would find themselves unable to control their investment, force liquidation, or freely sell the interest to a willing buyer, they would be unwilling to pay "full price" for the interest.

A "minority control discount" is applied to the value of the partnership interest to reflect its unattractiveness compared to other investment opportunities. As a consequence, it is possible to transfer interests in excess of exclusion caps without triggering gift taxes. Additionally, a portion of the interests transferred to family members under the lifetime exclusion will occur without income tax consequence to the recipient. The IRS no longer challenges the concept of minority discounts, but taxpayers must, nevertheless, provide credible evidence to support any claimed discount. Therefore, proper and accurate valuation is a critical step in forming an FLP.

Some Powerful Advantages
The minority discount allows a taxpayer to take maximum advantage of the $10,000 per year/per recipient gift tax exclusion. But beyond avoiding wealth transfer taxes, FLPs offer some significant non-tax advantages over other estate planning tools.

For example, the FLP transfers ownership of assets without relinquishing power of control. The parents may continue to operate a business or manage assets while diverting income streams to lower tax bracket family members. Assets remain consolidated and can be managed to optimize earning potential. Income can be diverted to children or grandchildren without encountering risks associated with inexperience or immaturity.

Another significant benefit of the FLP is asset protection. The creditors of limited partners cannot reach partnership assets. Only the partnership interests may be attached, and since limited partners cannot force liquidation, creditors are entitled only to share in the distribution of profits. This makes the limited partnership interest a rather unattractive asset to attach for judgment/debt satisfaction.

The FLP is not for Everyone
The FLP is not without some disadvantages. The most significant of these is cost. Since appraisal services are required in addition to legal services, FLPs are typically more expensive to form than other estate planning tools. As the asset base of the partnership becomes more complex, the appraisal fees will increase.

Other disadvantages relate to the type of assets involved. FLPs are not suited to holding only stocks or marketable securities. Also, when real properties comprise the partnership assets, transfer of interests totalling 50 percent or more will trigger tax reassessment under Proposition 13. Thus, the decision to form a FLP must carefully consider both the nature of the assets to be transferred and long-term gift strategies.

The FLP is not the right solution for every family, but in the right set of circumstances, it may be the ultimate tool for estate and family business planning.


Issue 3

LIVING WILLS: WORTHY & FLAWED

Living wills have figured prominently in the news following revelations that Jacqueline Kennedy Onassis and Richard Nixon had authored such declarations. A living will is a document containing advance instructions regarding life-prolonging medical treatment, which becomes effective upon incapacitation of the author. Considering the fact that America's population continues its trek through middle age, it's not surprising that concern over limits on medical treatment for terminally ill patients continues to grow. But are living wills the best answer? Critics say no.

Individuals who execute living wills may find their decisions ignored by doctors who are hesitant to withhold life sustaining treatment based on the strength of a piece of paper. Others may find their express wishes disregarded because of ambiguity. But these problems are avoided by those who execute a durable power of attorney for health care (DPA).

A DPA is a proxy appointment whereby an individual designates a third party to make decisions on their behalf in the event of incapacity. California is one of twenty-three states, which recognize DPAs created specifically for medical care decisions. Like living wills, they enable a principal to advance instructions to prolong or withhold treatment. However, unlike living wills, the instructions run to a designated third-party that holds power to make medical choices on behalf of the principal. By removing responsibility and control from the doctor, DPAs offer greater assurance that an individual's wishes will be respected in a time of medical crisis.

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