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