Structuring Preferred Partnership Freezes in Estate Planning: Navigating IRC Chapter 14 Valuation Rules

Transcription

1 Presenting a live 90-minute webinar with interactive Q&A Structuring Preferred Partnership Freezes in Estate Planning: Navigating IRC Chapter 14 Valuation Rules TUESDAY, APRIL 2, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Andrew L. Baron, Counsel, Meltzer Lippe Goldstein & Breitstone, Mineola, N.Y. Stephen M. Breitstone, Partner, Meltzer Lippe Goldstein & Breitstone, Mineola, N.Y. Lawrence J. (Larry) Macklin, Managing Director & Wealth Strategies Advisor, Bank of America Private Bank, Baltimore The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 1.

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5 STRUCTURING PREFERRED PARTNERSHIP FREEZES IN ESTATE PLANNING Strafford Webinar April 2, 2019 Larry Macklin Bank of America Private Bank Managing Director, Wealth Strategist Baltimore, Maryland

6 DISCLOSURE IMPORTANT: This presentation is designed to provide general information about ideas and strategies. It is for discussion purposes only since the availability and effectiveness of any strategy are dependent upon your individual facts and circumstances. Neither Bank of America Private Bank nor any of its affiliates or advisors provide legal, tax or accounting advice. Clients should always consult with their independent attorney, tax advisor, investment manager, and insurance agent for final recommendations and before changing or implementing any financial, tax, or estate planning strategy. Bank of America Private Bank operates through Bank of America, N.A., and other subsidiaries of Bank of America Corporation. Bank of America, N.A., Member FDIC Bank of America Corporation. All rights reserved. 0419LMA 6

7 INTRODUCTION Traditional Trust Based Freeze Estate Planning Grantor Retained Annuity Trust (GRAT) Sale to a Grantor Trust for a Promissory Note (a/k/a Sale to an Intentionally Defective Grantor Trust (SIDGT)) 7

8 GRAT AND SIDGT Two of the most common estate planning techniques Both provide a freeze in the value of the grantor s estate Both depend on the use of an Irrevocable Grantor Trust The income within a Grantor Trust is taxed to the Grantor whether or not the income is retained within the trust or distributed to the beneficiary A Grantor and his/her Grantor Trust cannot have an income tax transaction between them as they are treated as one income taxpayer 8

9 GRANTOR RETAINED ANNUITY TRUST (GRAT) Overview A GRAT is a strategy that allows transfer of all appreciation above a discount rate set by IRS to family beneficiaries over a period of time Provides for income stream to grantor (annuity payments in cash or in kind) over a specified number of years Requires that the grantor survives the term of the GRAT, or, generally, the full market value of trust property is included in the estate of the grantor Serial GRATs with staggered maturities can be used to mitigate risk of death during the term of a single GRAT Tax Benefits The retention of an annuity stream by the grantor reduces the value of the gift; the GRAT can be structured to provide for zero gift at inception A GRAT is most beneficial when funded with an asset that is expected to appreciate significantly Transfer of the assets to the trust does not create an income tax event Freezes value of assets in owner s estate at time of transfer and gives beneficiaries almost all of the upside benefit of appreciation 9

10 GRANTOR RETAINED ANNUITY TRUST (GRAT) Mechanics 1) Assets are placed into an irrevocable trust for a fixed term 2) Fixed or variable annuity is paid to grantor during term of the trust 3) At the expiration of the trust term, the remaining assets are passed to beneficiaries or to a trust for the benefit of the beneficiaries 1 Owner Transfer of Assets Annuity Payment 2 GRAT Beneficiaries 3 Remainder at Expiration 10

11 GRANTOR RETAINED ANNUITY TRUST (GRAT) #1 #2 #3 #4 #5 #6 If $1,000,000 is transferred to a GRAT... (1) Term 3 years 10 years 3 years 10 years 3 years 10 years (2) Annual Payment $100,000/year $100,000/year $346,753/year $111,326/year $374,111/year $135,867/year (3) 7520 rate 2.0% 2.0% 2.0% 2.0% 6.0% 6.0% Value of Retained Annuity $288,390 $898,260 $1,000,000 $1,000,000 $1,000,000 $1,000,000 Taxable Gift $711,610 $101,740 $0 $0 $0 $0 KEY OBSERVATIONS #1 & #2 - Notice how the amount of the taxable gift is smaller as the annuity term is extended. #3 & #4 These are zero-ed out GRATs - the annuity payments are increased so the value of the retained annuity almost exactly matches the amount of the transfer to the trust. #5 & #6 These are also zero-ed out GRATs however, because the 7520 rate increased, grantor will need to select a higher annual payment in order to zero-out the taxable gift. This results in less dollar value being left in the trust for the remainder beneficiaries after the expiration of the GRAT term. 11

12 SALE TO A GRANTOR TRUST FOR A PROMISSORY NOTE Overview Sale to an Intentionally Defective Grantor Trust (SIDGT) is a strategy that transfers future appreciation above an inter-family loan rate to family beneficiaries Assets are sold by the owner (not gifted) to the trust in exchange for an interest bearing promissory note Tax Benefits Sale to trust of assets does not generate income tax: Trust is structured as an intentionally defective grantor trust so that owner continues to be responsible for income taxes but transfer is considered a completed gift for gift/estate tax purposes Grantor remains responsible for all income tax on income earned by trust and income tax paid by grantor does not constitute additional gift to beneficiaries Freezes value of assets in owner s estate at time of transfer and gives beneficiaries almost all of the upside benefit of appreciation 12

13 SALE TO A GRANTOR TRUST FOR A PROMISSORY NOTE Mechanics 1) Grantor establishes trust; seeds trust with gift of cash or assets 2) Grantor sells assets to trust for a promissory note with intra-family interest rate 3) Interest and principal on note is paid on current or accrued basis 4) Excess value over note principal/interest remains in trust for beneficiary at the end of the note term with no gift tax due; only value included in owner s estate is the value of the promissory note 1 Owner Establish trust with gift 3 Interest Bearing Note Sale of shares 2 Defective Grantor Trust Excess Value over Note Principal remains in Trust for Beneficiary 4 13

14 COMPARING A GRAT VS. SIDGT GRAT SIDGT Authority Strategy s success requires assets to outperform IRS hurdle rate GST Planning Ability to stretch out payments Statutory IRS hurdle rate is 7520 rate (i.e., 120% of mid-term AFR) in effect when GRAT created Grantor cannot allocate GST Tax Exemption to GRAT while Grantor is receiving annuity payments Payment must be made annually and can increase no more than 20% over the previous year s payment Though well established, tax statutes do not create SIDGTs. A combination and interpretation of statutes yields this strategy IRS hurdle rate will always be lower than 7520 rate if SIDGT s term is 9 years or less Grantor can allocate GST Tax Exemption to seed gift to make SIDGT an exempt GST trust Can backload by using a balloon note where the principal balance is paid during last year of the installment note Ability to Zero Out Can zero out by following the approach done in the Walton Tax Court case Can zero out by not making a seed gift, though it is considered more aggressive Death during term: Estate tax result Death during term: Income tax result Grantor s Gross Estate will include amount required to produce the annuity using the 7520 rate in effect and grantor s death No income tax consequence Grantor s Gross Estate will only include the unpaid principal balance and accrued interest on the note Some say gain on installment note is triggered as IRD; some say not 14

15 FORMER PRESIDENT S PROPOSALS GRATS AND SIDGTS GRATs must have a minimum term of 10 years and a maximum term of the grantor s life expectancy plus 10 years GRAT remainder interests must have a minimum value equal to the greater of 25% of the value of the assets contributed to the GRAT or $500,000 Prohibits the grantor from engaging in a tax-free exchange of any asset held in a GRAT After a transfer to a SIDGT, all future trust investment returns will either be included in the grantor s estate or be a deemed gift from the grantor 15

16 GRATS AND SIDGTS UNDER UTILIZED? Both use irrevocable trusts Both require a third party trustee (after initial GRAT term) Grantor loses control Grantor loses future access to assets transferred Many would be Grantors, especially entrepreneurs, believe that they need to control and have access to as much wealth as possible in the future 16

17 A LITTLE BIT OF HISTORY Prior to 1987, Common Estate Planning included: Estate Freeze Senior transferred future appreciation of business to junior but retained control of the business Recapitalization into voting common, non-voting common, and preferred stock Transferred almost all value to non-cumulative preferred stock Transferred non-voting common with little value to junior Grantor Retained Income Trust Senior transferred property retaining an income interest (typically in nonincome producing property) and reduced the gift value reported by a significant, predetermined actuarial value of the income interest 17

18 A LITTLE BIT OF HISTORY The Revenue Act of 1987 attempted to limit this practice by modifying Internal Revenue Code (IRC) Section 2036(c) The Revenue Reconciliation Act of 1990 retroactively repealed the 1987 changes and added Chapter 14 (IRC Sections 2701 through 2704) These valuation rules remain the hurdles to transfer (estate/gift) planning today (Note: Section 2704 Proposed Regulations were withdrawn by the IRS on October 20, 2017) 18

19 STRAFFORD CLE CREDIT SEMINAR April 2, 2019 Structuring Preferred Partnership Freezes in Estate Planning 2019 Meltzer, Lippe, Goldstein & Breitstone, LLP All rights reserved. Stephen M. Breitstone, Esq Andrew L Baron, Esq. Meltzer, Lippe, Goldstein & Breitstone, LLP Sbreitstone@meltzerlippe.com Abaron@meltzerlippe.com

20 Presentation Overview Transfer Tax Planning vs. Basis Planning Uncertainty with Grantor Trusts Section Deemed Gift Issues with Preferred and Profits Interests Negative Capital The Issue with Grantor Trusts Freeze Partnerships to Maximize Basis Step Up Advanced Planning with Freeze Partnerships Recent Developments 20

21 Transfer Tax Planning v. Basis Planning

22 Lifetime Planning - the Trade Off Transfer future appreciating assets out of taxable estate No basis step-up May not be a good tradeoff especially with today s exemptions of $11,180,000 per person (through 2025) as adjusted for inflation (currently $11.4 million per person for 2019). 22

23 Income Tax And Transfer Tax Illustration Assets Real Estate (fmv) $10,000,000 Real Estate (basis) $1,000,000 Liabilities Mortgage ($8,000,000) Capital Equity $2,000,000 Estate Tax Equity subject to taxation $2,000,000 50% $1,000,000 Income Tax Gain on Sale Real Estate is Sold for $10,000,000 Gain subject to taxation $9,000,000 20% $1,800,000 25% $2,250, % Fed, NIIT, State & Local (NYC) $3,735,000 Transfer tax is on net equity Income tax is on gain realized, which includes nonrecourse debt 23

24 Uncertainty with Grantor Trusts

25 Uncertainty with Installment Sales to Grantor Trusts Lifetime termination of grantor trust status - tax consequences are well-settled The grantor has given up dominion and control, and the trust is now a separate taxable entity. Grantor is deemed to have transferred the assets and liabilities in the trust to the trust, for income tax purposes. Madorin v. Commr., 84 T.C. 667 (1985). See also Treas. Reg (c), Example 5 (1980), Rev. Rul , C.B. 222 and TAM , G.C.M (Aug. 23, 1977). 25

26 Uncertainty with Installment Sales to Grantor Trusts Death of grantor termination of grantor trust status - Sharp Disagreement Gain Triggered on Death of Grantor or Avoided? Basis Step-Up? Income in Respect of a Decedent? There is no case, regulation or ruling that directly addresses the income tax treatment. Rev. Proc No more rulings on step up upon termination of grantor trust status upon death of grantor. IRS Priority Guidance Plan Guidance on basis of grantor trust assets at death under Sec New Form 1065 check-the-box for negative capital accounts. Applies to negative capital account balances not otherwise reported on Schedule K-1. Penalties apply for failure to report. 26

27 Freeze Partnerships Advantages Negative Capital (liabilities in excess of basis) gain not triggered Basis step-up for frozen interest (including negative capital) Statutory guidelines under section 2701 Section 6166 estate tax deferral Considerations Highest hurdle rate Possible section 2701 deemed gift 27

28 Section 2701 Deemed Gifts

29 Introduction to Freeze Partnerships Two Classes of Ownership Preferred Interest Periodic cash distribution fixed (or tied to an established index) cumulative preferred return Liquidation preference - a priority distribution in a fixed amount upon liquidation Dividend Rate and Liquidation Preference is determined at the time of contribution to the entity (or recapitalization) The value of that interest is "frozen" as of that date Common Interest Cash distributions only if there is any money remaining after payment of the preferred return Entitled to all of the future increases in the income from underlying assets Appreciation in excess of preferred return inures solely to the common interest holders Senior Equity Preferred Interest Junior Equity Common Interest Freeze Partnership 29

30 Section 2701 Is there a transfer? Gift Sale Capital contribution Reorganization To or for the benefit of a "member of the family"? Generally, of an equal or lower generation Treas. Reg. Section Did the Transferor (or "applicable family member") retain an "applicable retained interest"? Applicable Retained Interest means distribution rights in family controlled entity and liquidation preference; or liquidation, put, call or conversion right Applicable Family Member means generally of an equal or higher generation 30

31 Section 2701 Zero Value Rule If there is a transfer under Section 2701, the retained interest will be valued at zero for gift tax purposes Exception: the transferor retains a "Qualified Payment Right"; or a liquidation, put, call or conversion right. 31

32 Exception To Section 2701 Zero Value Rule Straight Up Allocation Exception to Zero Value Rule All membership interests are of the same class All allocations are straight up Differences in voting rights are permitted Differences in liability permitted (e.g., GP v. LP) Marketable securities can be of a different class Vertical slice for fund managers 32

33 Section 2701 Qualified Payment Rights Qualified Payment Rights Periodic (at least annual) cumulative fixed payment rights Valued according to fair market value (FMV) Lower of Rule If a qualified payment right is held along with an extraordinary payment right the rights are valued as if each was exercised in the manner resulting in the lowest value for all such rights. Four Year Rule Any payment of a qualified payment made (or treated as made) either before or during the four-year period beginning on the due date of the payment but before the date of the taxable event is treated as having been made on the due date. 33

34 Entity Level Valuation - Family Owned The 2701 Regulations promulgated in 1992 provide that all family owned preferred interests are valued as if held by a single person. Exception for Capital Contributions. See, Treas. Reg (b)(1)(i). Contrast Rev. Rul (recognizing intra family valuation discounts). Lack of marketability discounts should apply to junior equity interest. 34

35 Deemed Gift is Determined the Subtraction Method Step 1 Entity Value Value all family-held interests as if held by one person (except capital contributions) Each family member is considered to have the right to liquidate and sell Step 2 - Subtract the value of senior equity interests Value determined as if held by one person (2701) Maximizes the value of the gift Step 3 Step 1 less Step 2 Allocate the remaining value among the transferred interests and other family-held subordinate equity interests. Apply certain discounts and other reductions as provided for by Treas. Regs (b)(4). Step 4 Subtract value of transferred interest. Remainder = Value of Gift $1,000,000 $0 ($100,000) $900,000 35

36 Minimum Value Rule Junior equity interests cannot be valued at less than 10% of: the total value of all equity interests in the entity, and the total amount of indebtedness of the entity to the transferor 36

37 Recapitalization Of LLC Caused Taxable Gift Under Section 2701 CCA Donor created an LLC and then gifted LLC interests to her children and grandchildren. LLC was then recapitalized - in exchange for children s agreement to manage LLC, all profits and appreciation would be allocated equally to children only, rather than to all members proportionately. After the recapitalization, Donor held only a right to distributions solely based on his capital account as it existed immediately before the recapitalization. The IRS stated that the recapitalization was a gift from Donor to Children under Section The IRS explained that a gift can occur indirectly through transactions such as a recapitalization. Citing Kincaid v US, 682 F.2d 1220 (5th Cir. 1982). Did not have to use 2701 to find gift here. Compare grant of a profits interest under Rev. Proc because grant of profits interest as compensation to child in business can trigger 2701 deemed gift. 37

38 The 2701 Attribution Rules Attribution to Estates, Trusts and other entities assuming maximum exercise of discretion fbo Grantor Trust Attribution Rules Multiple Attribution Rules Treas. Reg. Section (a)(5) different tie-breaker ordering rules apply: Cast a Wide 2701 Net. As to applicable retained interests Attribute to Senior Member first (Grantor of GT first) As to subordinated equity interests Attribute to Junior Member first 38

39 Planning with Freeze Partnerships

40 Valuing Preferred Interest - Rev. Rul FMV Facts & Circumstances Yield Preferred return coverage Dissolution protection Voting rights Lack of marketability Underlying assets Volatility Income production Market conditions Most Important Rate is lower if issuer cannot redeem 40

41 Valuing Preferred Interest Market Conditions The information provided is a compilation of the returns for preferred stock issued by publicly reporting REITS in each sector as of March 25, The information provided is not meant to be used for specific privately held companies without further analysis of each issue making up the sector s returns. In order to apply a sector's returns they most be adjusted to make them comparable to the subject company to which they are being applied. Market data courtesy of 41

42 Negative Capital

43 What is the Basis of Grantor Trust Assets Following Grantor s Death? Property Acquired by Sale - Section 1012 The basis of property shall be the cost of such property Property Acquired from Decedent - Section 1014 The basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall... be the fair market value of the property at the date of the decedent s death.. Property Acquired by Gift - Section 1015 The basis shall be the same as it would be in the hands of the donor, or the fair market value if lower 43

44 Uncertainty Creates Risk Is a Section 1012 or 1014 step-up too much to ask? No tax on gain ever No estate tax on trust assets Too good to be true? Rev. Proc No more rulings on step up upon termination of grantor trust status upon death of grantor IRS Priority Guidance Plan Guidance on basis of grantor trust assets at death under 1014 New Form 1065 check-the-box for negative capital accounts Applies to negative capital account balances not otherwise reported on Schedule K-1. Penalties apply for failure to report. 44

45 How To Structure Freeze Partnership with Negative Capital Liabilities Must be Allocated to Preferred to Obtain Step Up on Negative Capital 45

46 Structure To Keep Liabilities With Senior Senior Preferred Children 1% 99% Family Trust Grantor LLC Contributed Property $10,000,000 FMV $8,000,000 debt $2,000,000 equity $1,000,000 basis FREEZE PARTNERSHIP Junior Equity $222,222 Cash Contributed for Junior Equity (10% $2,222,222) IRC 704 (c) minimum gain IRC 752 Leveraged Real Estate 46

47 Treatment of Liabilities The way liabilities are allocated determines partnership outside basis and what gets stepped up upon death. Treas. Reg states basis = date of death value + share of liabilities allocated to the decedent/estate Section 752(a) increase in the partners share of liabilities is considered to be a contribution of cash to the partnership. Section 752(b) decrease in a partners share of liabilities is considered to be a distribution of cash. If the shifting of liabilities causes a partner to be deemed to have received a distribution in excess of that partner s basis in its partnership interest gain is recognized under section 731(c) of the Code. Inside basis is stepped up if there is a section 754 election. 47

48 Allocation Of Liabilities Among Partners Section 752 governs allocations of liabilities among partners Recourse - who bears risk of loss? Treatment of Nonrecourse debt three tiered approach Tier 1 Minimum gain Tier 2 Section 704 (c) minimum gain Tier 3 allocation based upon other significant partnership item with substantial economic effect 48

49 The Leaky Freeze Solution Capital Shift Capital Strip 49

50 What is a Capital Shift? The partners' interests in profits and losses may be altered or shifted in a number of ways during the course of a partnership's taxable year Shifts may result for many reasons, including for example: All or a portion of a partner's interest may be sold, exchanged, transferred, or contributed to a trust, etc. Partnership interests held by partnerships, corporations, or trusts may be distributed to partners, shareholders, or beneficiaries Shifts may also result from an agreement among the partners to alter their interests in profits and losses Freeze Partnership Capital Shift May decreased the value of the preferred interest for estate tax purposes, while leaving negative capital with Senior for step up 50

51 Capital Shift Senior Preferred Capital Shift Senior II Children 1% 99 % Family Trust Grantor Contributed Property $10,000,000 FMV $8,000,000 debt $2,000,000 equity $1,000,000 basis $1.5 equity (no debt) FREEZE PARTNERSHIP LLC Junior Equity $222,222 Cash Contributed for Junior Equity (10% $2,222,222) Leveraged Real Estate 51

52 Capital Shift Sale of Senior II for AFR note Leaves negative capital with Senior for step up Converts Preferred Return (say, 5% to 8%) to AFR return on shifted capital. April 2019 Mid Term AFR compounded annually is 2.55% No step up on Senior II if sold to Grantor Trust except to extent of installment note Estate side concerns regarding IRD if note is outstanding at death. 52

53 Capital Strip a/k/a Leveraging Up Real Estate contributed to Freeze LP Assets Real Estate (fmv) $10,000,000 Real Estate (adj. basis) $1,000,000 Liabilities Mortgage ($8,000,000) Net Equity $2,000,000 53

54 Capital Strip Balance Sheet Assets (FMV) $10,000,000 Mortgage ($8,000,000) Equity $2,000,000 Capital Accounts Senior $1,800,000 Junior + 200,000 $2,000,000 Preferred 6% Senior $1,800,000 x 6% $108,000 54

55 Capital Strip Borrow against separate stock portfolio $1.5 Million Margin Loan Investment Partnership $2 Million marketable securities $1.5 Million AFR Loan Freeze Partnership PartPerL P1P $1.5 Million Distribution To Senior 55

56 Capital Strip New Balance Sheet Assets (FMV) $10,000,000 Liability (Mortgage) Liability (AFR Loan) ($8,000,000) ($1,500,000) Equity $500,000 Capital Accounts Senior $300,000 Junior $200,000 Preferred 6% Senior $300, % $18,000 56

57 Capital Strip Preferred Return ($300,000 x 6%) $ 18,000 Interest on Mid Term AFR Loan ($1.5mm x 2.55%) (4/19) $ 38,250 Total Leveraged Return to Senior $ 56,250 Compare Unleveraged Return ($1.8mm x 6%) $108,000 Compare Installment Sale ($2mm x 2.55%) $ 51,000 57

58 Contributions Of Encumbered Property And Leveraged Distributions Disguised Sale Rules of Section 707(a)(2)(B) Under regulations prescribed by the Secretary... If (i) there is a direct or indirect transfer of money or other property by a partner to a partnership, (ii) there is a related direct or indirect transfer of money or other property by the partnership to such partner (or another partner), and (iii) the transfers described in clauses (i) and (ii), when viewed together, are properly characterized as a sale or exchange of property... Contribution and distribution will be treated as a sale if the facts and circumstances indicate that (Treas. Reg (b)(1)) (1) the transfer of money would not have been made but for the transfer of the property, and (2) the distribution was not dependent on the "entrepreneurial risks" of the partnership's operations. Additionally, if within a two-year period there is a contribution by and distribution to a partner, the transfers are presumed to be a sale of the property to the partnership. This presumption is rebuttable only if "the facts and circumstances clearly establish that the transfers do not constitute a sale." 58

59 Disguised Sale Rules and Leveraged Distributions Key Takeaways 1. If the debt comes on more than 2 years before the contribution of encumbered property, the disguised sale rules do not apply. The debt is allocated to the contributing partner under section 704(c) principles. 2. Disguised sale rules can limit preferred returns that should be paid during the first 2 years. 3. Leveraged distributions (i.e. debt financed) within 2 years of contribution can be an issue under the disguised sale rules. 59

60 Simple Real Estate Partnership Freeze Senior Preferred Interest (6% qualified payment and Liquidation Preference) Junior Equity (Growth Interest) Family Trust Grantor Trust Managing Member Interest Freeze Partnership RE LLC RE LLC RE LLC 60

61 Best Discount Scenario (Contribution of Non-controlling Interest) Senior Preferred Junior Equity Family Trust Unrelated Parties FREEZE PARTNERSHIP 40% Membership Real Estate Entity 61

62 Reverse Freeze Remember when there was a return on investment? Family Trust that includes spouse Preferred Interest (8% qualified payment and Liquidation Preference) Junior Equity (Growth Interest) Senior Freeze Partnership 1992 Regs do not allow intra family discounts! Undiscounted Assets. 62

63 PREFERRED PARTNERSHIP TO CONTAIN GROWTH OF GST NON-EXEMPT TRUST GST Non-Exempt Trust Distribute $22.26M to each child/beneficiary (G-2) Child 1 Child 2 $22.36M gift* $22.36 M gift* Preferred Frozen Shares Exempt Trust fbo Child #1 descendants Exempt Trust fbo Child #2 descendants Preferred Partnership Common Growth Shares Investments *Assuming split gifting with spouse 63

64 PREFERRED PARTNERSHIP WITH QTIP FREEZE Spouse Income QTIP Trust Child/ Trust Preferred Coupon Common Capital Contribution Capital Contribution Preferred Partnership * Caveat Consider potential Section 2519 argument on contribution. 64

65 CARRIED INTEREST VERTICAL SLICE PLANNING Example GP Carry $1M LP Capital $20M If Parent makes a Vertical Slice gift of 50% of his $1M GP interest (= $500,000), he must also make a proportional gift of 50% of his $20M LP capital (= $10M). Total gift of $10.5M x 40% gift tax rate = $4.2M gift tax liability. 65

66 NON-VERTICAL PREFERRED PARTNERSHIP Parent Parent Gift of Common Growth Interests in LLC Child/ Trust Common and Preferred (with Mandatory Payment Right, Qualified Payment Right or guaranteed payment) LLC Interests Contribute GP and LP Fund Interests Preferred LLC Common GP LP LLC FUND 66

67 Recent Developments Malpractice case against Lowenstein Sandler and CohnReznick (Feb. 2019) Advisors allegedly recommended clients with extensive real estate holdings transfer assets by gift and/or sale to dynastic grantor-type trusts. Real estate partnerships allegedly had negative capital accounts. Clients sued advisors alleging that they never advised them that conveying real estate to dynasty trusts could eliminate basis stepup at death, trigger phantom gains upon termination of grantor trust status and cause loss of future depreciation deductions. Form 1065 Check-the-Box for Negative Capital Accounts Applies to negative capital account balances not otherwise reported on Schedule K-1. Penalties apply for failure to report. Increased IRS scrutiny 67