S. Stacy Eastland Houston, Texas

Transcription

1 SOME OF THE BEST SYNERGISTIC FAMILY LIMITED PARTNERSHIP OR FAMILY LIMITED LIABILITY COMPANY ESTATE PLANNING IDEAS WE SEE OUT THERE (That Also Have the Merit of Playing Havoc With Certain Conventional Wisdom ) S. Stacy Eastland Houston, Texas

2 Goldman Sachs does not provide legal, tax or accounting advice. Any statement contained in this communication (including any attachments) concerning U.S. tax matters was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code, and was written to support the promotion or marketing of the transaction(s) or matter(s) addressed. Clients of Goldman Sachs should obtain their own independent tax advice based on their particular circumstances.

3 Table of Contents I. THE PRIMARY IMPORTANCE OF GOALS-BASED PLANNING FOR THE SUCCESSFUL SUCCESSION OF THE FAMILY WEALTH IRRESPECTIVE OF THE STATUS OF THE TAX LAW...1 A. The Importance of First Determining a Client s Goals That Determine the Estate Plan s Essential Strategies The Prevalence of Tax Driven Wealth Preservation Focus and Four Suggested Rules to Change the Priority of That Focus Estate Plans Developed Around the Stewardship Purpose of the Family Wealth Organizational Pattern of a Purpose-Based Estate Plan: Compatibility of Strategies and Legal Structures with the Stated Purpose of the Family Wealth....3 II. A FREQUENTLY MENTIONED GOAL (OR CONCERN) WITH RESPECT TO CURRENT GIFTING OPPORTUNITIES: THE DESIRE FOR EXIT STRATEGIES TO MEET UNANTICIPATED CONSUMPTION NEEDS AND/OR CHANGING STEWARDSHIP GOALS...3 A. Tax Relief, Unemployment, Insurance Reauthorization and Job Creation Act of 2010 (hereinafter the Tax Act of 2010 )....3 B. The Desire for Flexibility for Many Clients in Making Gifts in III. THE CONTROL ADVANTAGES AND CONSIDERATIONS FOR A TRANSFEROR CONTRIBUTING ASSETS TO A FAMILY LIMITED PARTNERSHIP (FLP) (OR A FAMILY LIMITED LIABILITY COMPANY ( FLLC ))....5 A. Brief Summary....5 B. Analysis of Case Law Supreme Court Analysis....7 i

4 2. Tax Court Analysis By Judge Cohen in the Strangi Case Full Tax Court Analysis in the Cohen Case C. Six Separate Methodologies That May Prevent Running Afoul of IRC Sec. 2036(a)(2) Inclusion With Respect to Managing Partner Donors and Owners of Partnership Interests Successfully Making the Argument That the O Malley Analysis and the Prerequisites of IRC Sec. 2036(a)(2) Are Not Applicable to a Donor Partner, Who Retains a Distribution Power Over a Family Partnership Taxpayers Should Consider Adopting a Strategy of Selling Partnership Interests (Perhaps to Defective Grantor Trusts) in Exchange For a Note or Other Full Consideration IRC Sec. 2036(a)(2) Inclusion Should Not Present Any Issues if the Partnership Agreement is Structured to Provide the Same Fiduciary Constraints That Mr. Byrum Had IRC Sec. 2036(a)(2) Inclusion Should Not Present Any Issues if the Donor Partner s Distribution Power is Limited By Standards That a Court Could Enforce IRC Sec. 2036(a)(2) Inclusion Should Not Present Any Issues if the Donor Partner Contributes the Partnership Interest That Controls the Distribution Power to a Trust and Retains the Power to Remove and Replace the Trustee in a Manner That Complies With Revenue Ruling IRC Sec. 2036(a)(2) Inclusion Should Not Present Any Issues if the Donor Partner Contributes the Partnership Interest That Controls Distribution Powers to a Corporation That Has the Same Considerations and Constraints in its Structure as Existed in Byrum and Complies With Revenue Ruling D. Conclusion IV. BEST FAMILY INVESTMENT PLANNING IDEA OR WHY INVESTMENT PROFESSIONALS LOVE FAMILY LIMITED LIABILITY COMPANIES AND/OR FAMILY LIMITED PARTNERSHIPS...19 A. Introduction ii

5 B. Investment and Trustee Management Reasons For the Use of Closely Held Limited Partnerships for the Investor Who Wishes to Create Trusts and Invest in Alternative Investment Classes, as Modern Portfolio Theory Seems to Require The Case For Diversification Into Several Asset Classes, Including So-Called Alternative Investments a. Introduction b. Simplified examples analyzing the effect of diversification The First Investment Reason Certain Trusts Are Benefitted By the Creation of Family Limited Partnerships: Closely Held Family Limited Partnerships May Facilitate the Ability of Smaller Trusts to Hold Alternative Investments and Follow Modern Portfolio Theory a. Securities laws b. The Securities Act of 1933 and the Securities Exchange Act of c. Investment Company Act of d. The outcome The Second Investment Reason Certain Trusts Are Benefitted By the Creation of Family Limited Partnerships: Closely Held Family Limited Partnerships Facilitate Income Only (So-Called Simple) Trusts to Be Fully Diversified, as Modern Portfolio Theory Seems to Require a. Closely held limited partnerships could be a tool to manage distribution fairness issues associated with distributions (or lack of distributions) from alternative investments for income only trusts b. Trusts: Income-only marital trusts c. Partnerships: Basic income tax primer d. Trusts: Basic income tax primer e. Trusts: Basic fiduciary accounting income primer f. Trusts: Distributable net income iii

6 g. Trusts: Uniform Principal and Income Act h. Trusts: Prudent Investor Act i. Trusts: Allocating taxes between trust and beneficiaries j. Possible equitable and flexibility solution for the trustee that owns or desires to own alternative investments: Placing alternative investments in FLP structures The third investment reason certain trusts are benefitted by family limited partnerships: the closely held family limited partnership has the management capacity to carry out the partnership s capital gains income to the income-only beneficiary for incoe tax purposes C. If the Closely Held Family Limited Partnership Facilitates the Indirect Ownership of a Fully Diversified Portfolio By Smaller Trusts and Income Only Trusts, Will that Partnership Be Recognized For Transfer Tax Purposes?...42 V. OTHER NON-TRANSFER TAX REASONS WHY FAMILIES FORM FAMILY LIMITED PARTNERSHIPS OR FAMILY LIMITED LIABILITY COMPANIES...49 A. A Taxpayer, By Using the Partnership Vehicle, Has the Ability to Transfer Capital Without Killing the Transferee s Productivity and Initiative, Because the Taxpayer May Have Some Indirect Control Over Distributions, Which May Not Be Possible With the Trust Vehicle B. The Partnership Vehicle Simplifies Annual Giving For Private Equity Investments C. Partnership Vehicle Facilitates Assets That Are Important to Be Kept in the Family D. Partnership Vehicle Provides Some Protection Against a Taxpayer s Future Unforeseeable Creditors, Which Cannot Be Provided to That Taxpayer Under Most States Law By Using Trusts E. The Partnership Vehicle Provides Greater Protection of Gifted Assets Against Failed Marriages F. Unlike Irrevocable, Non-Amendable Trust Agreements, Partnership Agreements Are Comparatively Flexible iv

7 G. Business Judgment Rule of Partnership Law Offers Greater Flexibility in Investment Management Than Trust Law H. Partnership Agreements Could Be Drafted to Mandate Arbitration of Family Disputes and Circumvent Court Litigation, Which is Generally Not Possible Under Most State Laws With Respect to Trusts I. Partnership Agreements Could Be Drafted to Mandate the English Rule For Disputes (Loser Pays); That is Generally Not Possible Under Most State Laws With Respect Too Trusts J. Partnership Arrangements Facilitate and Institutionalize Family Communication and Education on Financial Matters K. Partnerships Eliminate or Lower Out-of-State Probate Costs For Real Estate Investments L. A Partnership is Advantageous Compared to a C Corporation Because it Has One Level of Income Tax and is Advantageous Compared to an S Corporation Because it Allows a Greater Variety of Ownership Structures M. A Partnership is Advantageous Compared to a Corporate Structure Because in Many Jurisdictions There is No Franchise Tax or Intangibles Tax to Pay With the Use of Partnerships VI. BEST FAMILY LIMITED PARTNERSHIP OR FAMILY LIMITED LIABILITY COMPANY ESTATE PLANNING IDEA FROM A TRANSFER TAX PERSPECTIVE SELL IT...53 A. Introduction B. A Perspective of Modern Integrated Estate Planning C. The I.R.C. Section 2036(a)(1) Problem For Decedents Who Retain a Significant Family Limited Partnership Interest Brief summary a. Either the taxpayer fails to demonstrate that there is at least one substantial non-tax reason to establish the partnership, or the capital accounts of the partnership do not reflect interests proportionate to the contributed property; and...55 v

8 b. The taxpayer and the partnership have practices that demonstrate an implied or actual agreement to retain possession or enjoyment of the income of the contributed assets to the partnership back to the taxpayer Analysis of case law a. Key cases that have not been reviewed by a circuit court b. Tax Court and Fifth Circuit analysis in the Estate of Strangi of whether I.R.C. Section 2036(a)(1) could include assets contributed to a partnership by a decedent, if the decedent never makes a taxable gift c. District Court and Fifth Circuit analysis in the Estate of Kimbell of whether I.R.C. Section 2036(a) could include assets contributed to a partnership by a decedent, if the decedent never makes a taxable gift d. Tax Court and Third Circuit analysis in Turner (the so-called Thompson case) of whether I.R.C. Section 2036(a)(1) could include assets contributed to a partnership by a decedent, if the decedent never makes a taxable gift e. Tax Court and First Circuit analysis in Abraham f. Tax Court and Eighth Circuit analysis in Korby...69 g. Tax Court and Ninth Circuit analysis in Bigelow D. The I.R.C. Section 2036(a)(1) Problem Does Not Exist if There is a Substantive Non-Tax Reason For the Creation of the Family Limited Partnership E. If a Sale of a Partnership Interest Occurs During a Client s Lifetime, the Gift Tax Equivalent of I.R.C. Section 2036 Does Not Exist (i.e., There Is No I.R.C. Section 2536 Under Chapter 12 of the Code) F. There Are Many Other Reasons, Other Than Avoiding I.R.C. Section 2036(a)(1) Inclusion, for Transferring the Partnership Interest During the Taxpayer s Lifetime For a Note The valuation principles of Revenue Ruling apply to lifetime transfers, but they do not apply to transfers at death vi

9 2. Growth of the underlying assets of the partnership, if a transfer occurs during the lifetime of a taxpayer, will not be subject to estate tax There is a significant transfer tax advantage for the taxpayer who transfers his partnership interests during his lifetime to a grantor trust in exchange for a note A future Congress could change the current law with respect to valuation discounts associated with family limited partnerships The taxpayer may have the ability to indirectly access all of the partnership distributable cash flow for consumption needs Generally, the sale of a family limited partnership interest to a trust, is a flexible arrangement that can be modified in response to changed circumstances The sale of a limited partnership interest for a note facilitates testamentary charitable planning, because the note is a more attractive asset for a charity to receive than family limited partnerships interests VII. FIRST SALES METHOD: THE ADVANTAGES AND CONSIDERATIONS OF A TRANSFEROR SELLING FAMILY LIMITED PARTNERSHIP INTERESTS (OR NON-MANAGING MEMBER INTERESTS IN A FAMILY LIMITED LIABILITY COMPANY ( FLLC )) TO A TRUST IN WHICH THE TRANSFEROR IS THE INCOME TAX OWNER ( GRANTOR TRUST ), THAT NAMES THE TRANSFEROR S SPOUSE AS BENEFICIARY AND GIVES THE SPOUSE A SPECIAL POWER OF APPOINTMENT...78 A. What is the Technique?...78 B. Advantages of the Technique Tax Advantages of Creating a Grantor Trust and a Sale to a Grantor Trust The Near Term Death of the Grantor of a Grantor Trust Generally Does Affect the Technique Like the Death of a Grantor of a GRAT The Appreciation of the Assets of the Trust Above the Interest of the Note Used in Any Sale to a Grantor Trust for the Grantor s Spouse Will Not Be Taxable in the Grantor/Seller s Estate vii

10 4. Flexibility Advantages of Selling to a Grantor Trust, Naming the Grantor s Spouse as a Beneficiary and Giving a Grantor s Spouse a Special Power of Appointment C. Considerations of the Technique There May Need to Be Substantive Equity in the Trust From Prior Gifts (is 10% Equity Enough?) Before the Sale is Made State Income Tax Considerations The IRS Could Be Successful in Applying the Step Transaction Doctrine to the Technique If the Assets Decrease in Value, the Gift Tax Exemption Equivalent May Not Be Recoverable The IRS May Contest the Valuation of Any Assets That Are Hard to Value That Are Donated to a Grantor Trust or Are Sold to Such a Trust a. Introduction b. Defined value allocation clauses involving a charity c. Defined value allocation clauses involving a residual gift to a marital deduction trust d. Defined value allocation clauses involving gifts to a grantor trust and a grantor retained annuity trust ( GRAT ) e. Defined value allocation clauses involving a defined dollar transfer by the donor VIII. THE SECOND SALES METHOD: THE ADVANTAGES AND CONSIDERATIONS OF A TRANSFEROR CONTRIBUTING ASSETS TO A GRAT IN WHICH THE REMAINDER TRUST IS FOR THE BENEFIT OF THE TRANSFEROR S SPOUSE AND FAMILY AND WHICH ALSO GIVES THE TRANSFEROR S SPOUSE A LIMITED POWER OF APPOINTMENT A. What is a GRAT? B. Advantages of the Technique Valuation Advantage of a GRAT viii

11 Find the full text of this and thousands of other resources from leading experts in dozens of legal practice areas in the UT Law CLE elibrary (utcle.org/elibrary) Title search: Some of the Best Family Limited Partnership and Family Limited Liability Company Estate Planning Ideas We See Out There Also available as part of the ecourse Family Limited Partnerships: Creation and Maintenance; Estate Planning Techniques; plus Dysfunctional FLPs First appeared as part of the conference materials for the 2012 LLCs, LPs and Partnerships session "Some of the Best Family Limited Partnership and Family Limited Liability Company Estate Planning Ideas We See Out There (That Also Have the Merit of Playing Havoc With Certain "Conventional Wisdom")"