Transfers at death (but not lifetime gifts) result in an increase in the basis for computation of capital gain for the asset transferred to the fair market value at the date of death (or an optional alternate valuation date. This means that careful consideration should be given to the selection of assets which are transferred intervivos (lifetime gifts) and those transferred at death (whether by will or by trust).

Irrevocable Life Insurance Trust

                        If your estate on second death is likely to incur estate taxes any life insurance payable at that time will also be subject to tax. This can be avoided by use of a trust which owns a policy and which is the beneficiary. A trust of this type can also have provisions related to educational expenses and delay any distributions until all children have completed their education or reached designated ages.

Family Limited Partnership

                        A family limited partnership is a limited partnership composed of a general partner and limited partners. The general partner, who has the power to make virtually all decisions on behalf of the partnership, is generally an entity (an S corporation or limited liability company (LLC)) controlled by family members. The general partner ordinarily has a very small percentage interest in the partnership (usually one percent). The initial limited partners are the members of the older generation, who have a very large percentage interest in the partnership (usually 99 percent). Under the partnership agreement, the limited partners have no rights to participate in the day-to-day management of the partnership. The partners contribute investment assets, and profits and losses are allocated pro-rata to the partners. The limited partners may, and frequently do, make gifts of limited partnership interests to the younger generation during their lifetimes.

Tax Advantages

                        The principal tax advantage is a valuation discount, usually of from 30 to 48 percent on the value of the transfer subject to tax. Discounts may exceed 50 percent in appropriate circumstances, but there is penalty exposure if such a discount is completely disallowed. The transfer tax savings is generally a highly important reason for a client to utilize a limited partnership. The discount is generally greater for real estate and less for publicly traded securities. It is also generally greater when the property does not produce cash flow.

                        The valuation discount arises because non-controlling ownership interests in business or investment entities are not valued at the value of a proportionate interest in the underlying assets (net asset value). Recognized valuation methodology provides that such interests are entitled to discounts for lack of marketability and control. These discounts recognize the economic realities that such interests cannot be sold for net asset value because they are not marketable ? that is, they cannot be readily sold like shares of stock in a publicly traded corporation ? and they do not permit the transferee to exercise control over the activities of the business or investment entity, thus resulting in the owners? subjection to the discretion and business judgment of another party both for operating results and the timing of distributions (if any).

                        Trying to quantify the expected tax savings involves determining when property is likely to be sold as well as determining effective transfer tax and income tax rates. In general, the transfer tax savings must be offset against the present value (as of the time the transfer tax would have been paid) of the income tax cost resulting from the reduced basis step-up (which applies only if the estate tax applies because the limited partnership interest is included in the decedent?s estate). If property is expected to be retained in the family for many years, the income tax offset can be ignored. Also, when the property is sold there will be cash proceeds to pay the tax, which is not the case with the transfer tax.

Non-Tax Advantages

The non-tax reasons to form a family limited partnership include:

            Transfer a group of assets into a form of ownership that is simpler to transfer (to facilitate annual and other gift-giving programs).

            Centralize management and obtain the benefit of continuity of management over the partnership?s assets.

            Provide protection to partnership assets from claims of future creditors of the limited partners and to limit the limited partners? liabilities for partnership debts.

            Provide unified control (through the general partner) over distributions of cash derived from earnings on the partnership?s assets.

            Provide flexibility in business planning not available through trusts, corporations or other business entities.

            Conduct investment and business activities in an entity that is not itself subject to federal or state income taxes.

            Avoid the delay, publicity, inconvenience and expense associated with probate administration of multiple separate investments of the partners upon their respective deaths or liquidation.

Disadvantages

            Locks assets in the partnership for a period of time, generally not ending until the expiration of the statute of limitations for the last year during which transfers were made.

            Records must be kept, and annual tax returns must be filed, for the partnership and the corporate or LLC general partner. Appraisals must be made to establish the value of the gifted limited partnership interest. The investment in legal, accounting and appraisal fees for formation and administration are significant, but the savings achieved often exceed costs by a multiple of 20 or more.

            Use of a family limited partnership clearly increases the chance of gift or estate tax return being examined, and perhaps contested in court. There are many ?traps for the unwary? if partnership form is not respected.

            Could create or increase liquidity problems of estate by locking up assets that could otherwise be used to pay estate tax.

            Could be problems if highly leveraged real estate is being transferred to the partnership.

            Could be income tax problems if property is distributed to donees within seven years of contribution (see disguised sales rules of Sections 731(c) and 737 of Internal Revenue Code).