Tax Secrets: How to use the perfect tax-planning strategy

The courts beat the IRS over the head every time the IRS complains about some aspect of family limited partnerships (FLIPs). My clients – mostly readers of this column – not only use FLIPs (often), but love 'em. I love FLIPs too. So does all 50 of the United States; each state has passed legislation recognizing FLIPs.

Note: The big issue for FLIPs is discounts. For example, if you transfer $1 million of assets (like stocks, bonds, CDs, real estate or other investment type assets) to a FLIP, a 35 percent discount allowed by the IRS would make those assets worth only $650,000 for tax purposes. In a 40 percent estate tax bracket, you would save $140,000 in taxes for every $1 million transferred to your FLIP. A big deal!

Following are a couple of cases that show our side has conquered the IRS using the FLIIP strategy.

In an important case (Knight 115 TC 36), the IRS wanted to disregard the FLIP for gift tax purposes because it lacked economic substance. The Tax Count court beat up the IRS on three counts: (1) Since the FLIP is valid under the local law (here Texas), it must be recognized by the IRS. The lack of economic substance argument just doesn’t hold water. (2) The IRS objected to any discount for the gifts of the FLIP interests (44.6 percent) to Knight’s two kids (22.3 percent to each). Sorry, said the court, allowing a larger valuation discount on the two FLIP interests gifted. (3) The IRS tried to nail Knight on a technical issue involved in a “family controlled entity” (tell your professional to look at Section 2704(b)) Again the court said, “No.” Strike three.

This next case (Estate of Elma Middleton Daily, TC Memo 2001-263) is a huge tax victory for FLIPs. Elma gifted some FLIP interests during her life. She died still owning an interest (the portion not gifted) in the

FLIP. The IRS opted for a valuation discount of 15.75 percent for the lifetime gifts and 13.51 percent for her estate’s interest in the FLIP.

Now here’s a wonderful fact: The assets in the FLIP were marketable securities (like Exxon and AT&T). The Tax Court awarded a discount of 40 percent for both gift and estate tax purposes. Ring the victory Bells! (Hey, that’s $400,000 in discounts for each $1 million you decide to put in your FLIP). Estate tax savings in a 40 percent estate tax bracket: $160,000.

Wow!

One warning: The court made it clear that the valuation issue (translate, “amount of discount allowed”) is fact driven. The quality of the valuation expert you hire can make or break your sought-after tax results. The lesson: only work with pros who have experience with FLIPs.

There are about 20 reasons for doing a FLIP. Here’s the top three: (1) You can give away property (via interests in the FLIP) for gift tax purposes, yet you maintain absolute control for as long as you live; (2) The huge discounts allowed as described above; (3) The assets inside the FLIP are protected from creditors and ex-spouses (for example, if one of your kids gets divorced and owns a portion of your FLIP, your ex-daughter-in-law or ex-son-in-law, is legally locked away from all of the FLIP assets).

You can transfer almost any kind of property to a FLIP (stocks, bonds, real estate, other investments). However, you would not transfer stock in your S corporation or any qualified plans (like an IRA, 401(k) or profit-sharing plan) to a FLIP. There are other tax-advantaged strategies to handle these two types of assets.

About 70 percent of the wealth transfer plans and estate plans we do for readers of this column utilize one or more FLIPs. Look into FLIPs. You’ll be glad you did.

If you need help to get started on your FLIP or your estate plan, you should browse my website, taxsecretsofthewealthy.com. If you are in a hurry and/or have a question, just pick up the phone and call me (Irv) at 847-767-5296. Or email me: irv@irvblackman.com.