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Life Health > Life Insurance

Using Triple Leveraged Family Limited Partnerships

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After years of declining use due to uncertainty about their effectiveness, family limited partnerships are regaining their position as a prominent tax planning tool. The reason: the significant leverage that can be achieved using FLPs with life insurance acquired via premium financing techniques.

Triple leveraging is accomplished by combining the tax advantages of the FLP with the death benefit of a life insurance policy at a multiple of premiums paid, then employing premium financing to reduce the outlay necessary to pay the premiums on the life insurance policy.

Family Limited Partnerships: The First Leverage

FLPs protect family wealth and reduce estate taxes while permitting a measure of control over the assets of the FLP. Typically, the older generation (i.e., the parents) will establish the FLP and fund it with assets the parents own. The parents will be issued the general partner (GP) interest and the limited partnership (LP) interests in exchange for the assets they contributed.

The first leverage comes with the valuation discounts available when the parents transfer the LP interests to their children, typically by making gifts of the discounted LP interests. The most common valuation discounts used in transferring FLP interests are: (1) lack of marketability of the interests and; (2) a minority interest discount, which the parents enjoy because they don’t have majority ownership of the partnership.

Once LP interests have been gifted, they are excluded from the parents’ estates.

Because of all the benefits associated with FLPs, they have come under fire from the Internal Revenue Service for being a device to avoid paying estate taxes. The courts have provided rules to follow when establishing an FLP, as follows:


o Transfer essentially all of the taxpayer’s assets to the FLP;

o Put a primary residence and other personal assets into the FLP;

o Establish an FLP right before death;

o Pay personal expenses directly from the FLP;


o Have a legitimate business purpose under state law for the FLP;

o Maintain adequate assets outside of the FLP to cover normal living expenses of its creator;

o Document the reasons for creating the FLP.

Uses of Life Insurance in FLPs: The Second Leverage

The FLP can be an attractive alternative to an irrevocable life insurance trust (ILIT) for owning the life insurance policy. By placing the policy in the FLP, the partnership enjoys the receipt of the tax-free death benefit for the low premium cost.

Because the FLP is governed by state statute and contract law, it offers greater flexibility and control to the insured than does an ILIT; the partnership arrangement may be changed by simply amending the partnership agreement. Moreover, the partnership has greater ability than an ILIT to pay premiums without the need for taxable gifts. FLP assets and income from those assets are available to make premium payments.

The partnership allows the insured continuing participation, as a general partner, in the administration of partnership property. Any proceeds payable to the FLP on the death of the insured, when the policy was owned and paid for by the FLP, should not be includible in the insured’s estate, except for the corresponding increase in the value of the percentage ownership of the insured that results from the ownership by the FLP of the life insurance partnership.

Premium Financing: The Third Leverage

The third and final leverage is the application of premium financing to the acquisition of the life insurance. Premium financing is a technique designed for individuals who have a life insurance need but do not wish to liquidate assets to fund the life insurance policy.

In this arrangement, an individual will borrow from a third-party lender to pay premiums on a life insurance policy. Premium financing is suitable for those individuals who believe they can earn a rate of return in excess of the interest rates charged by the lender. The premium financing outlay is the interest due on the loan.

To illustrate, assume that a married couple, ages 70 and 68, has three children and a net worth of $10 million. The couple’s assets include commercial properties with a market value of $2.6 million. These properties generate income of 6% annually and appreciate at 7% annually.

The parents transfer properties to an FLP in exchange for a 1% general partnership interest and a 99% limited partnership interest. They then use their $1 million lifetime gift exemptions ($2 million total) to transfer the 99% LP interests to their children gift tax-free employing a 30% valuation discount, which reduces the $2.6 million to $2 million for gifting purposes.

The parents will retain the 1% general partnership interest; only this interest will be includible in their estate. The FLP then purchases a $5 million second-to-die life insurance policy on the parents.

Although the properties generate approximately $156,000 annually (which could be used to pay premiums), the family leverages the life insurance using a premium financing strategy. The couple selects a second-to-die policy with a return of premium death benefit option to repay the loan at the second death and to provide the FLP with the full $5 million of death benefit. The table summarizes the program.

The key numbers for comparison purposes are the internal rates of return (IRRs), which demonstrate the efficiency of premium financing over non-financed insurance. In addition, the difference between the annual outlays for financed insurance and non-financed insurance can be invested in the FLP’s assets to further increase the value.

We have demonstrated how to achieve triple leverage with the FLP by:

o Reducing the taxable estate by transferring properties at a discount to the FLP (only the general partnership interest of $76,000 (1% of $7,600,000) will be includable in the estate);

o Purchasing life insurance inside the FLP to increase FLP assets to $7.6 million from $2.6 million; and

o Leveraging the life insurance purchase using a premium financing strategy.

The end result is that a significant percentage of assets can be transferred outside the taxable estate and can be leveraged to grow in value for the benefit of future generations.


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