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Question: My mother is an elderly widow in poor health. The bulk of her estate consists of her home, worth about $200,000, an IRA she got from my father, worth about $200,000, and a securities portfolio worth a little over $800,000. On the advice of her CPA, she has been making annual $10,000 gifts of securities to me and to my husband, and to my brother and his wife, as well as to the six grandchildren. However, with the wild rise in the stock market the past few years, this hasn't even kept up with the appreciation in her portfolios.

Her CPA tells her that she should consider doing more to shield her estate from death taxes. We agree. While we're happy to see our mother spend as much money as she wants on herself, we don't particularly want to lose any more of our inheritance to taxes than we have to. One of the suggestions he had was a "family limited partnership." What is a family limited partnership and how can it help our family's situation? Won't using something like that mean that my mother will have to give up control of her assets?

Family Limited Partnerships ("FLPs") and Family Limited Liability Companies ("FLLCs") provide substantial leverage when making gifts for estate planning purposes, because gifts of limited partnership units are worth a good deal less than the underlying assets owned by the partnership -- even when the underlying assets consist primarily of securities. How much less? Often between 20% to 50%, sometimes even higher, depending on the underlying assets and the aggressiveness of the planning.

In North Carolina, we prefer to use limited liability companies since the North Carolina LLC Act has been recently amended to make FLLC estate planning more advantageous. A major advantage of using a FLLC for gifting is that your mother can retain control of the partnership assets. Discounts are set by an appraisal of the value of the FLLC units themselves, which is in addition to the required valuation or appraisal of the underlying LLC assets. By the way, under state law, there is no legal difference between a "family" limited partnership or "family" limited liability company and a "regular" limited partnership or limited liability company. The terms "family limited partnership" and "family limited liability company" are merely estate planning terms.

To use a family LLC for estate planning, your mother would transfer assets (cash, securities, a vacation home or unimproved property, perhaps) a newly formed LLC. Your mother would receive manager and non-manager interests in the LLC (similar to general and limited partnership interests). Appraisals and/or valuations of the assets of the LLC would be obtained from a portfolio valuation service and/or qualified appraisers. Then, appraisals of the interests to be gifted would be obtained from a qualified business appraiser. The appraisals are essential in substantiating the value of the gifts. Proper FLLC planning cannot be done without such appraisals, and failure to obtain proper appraisals could subject the donor to IRS penalties.

Your mother would then make gifts of non-manager LLC interests to her intended donees (you, your brother, your spouses, the grandchildren, etc.) using the gift tax annual exclusion you are already familiar with, and, if your mother wishes, some or all of her lifetime federal estate and gift tax exemption amount. ($675,000 in 2000). Be sure to be aware of the North Carolina gift tax, however. Gifts to anyone other than lineal descendants (children, grandchildren, etc.) do not qualify for the North Carolina lifetime gift tax exemption (only $100,000 - it is not the same as the federal amount). That means that gifts over $10,000 per year to in-laws are taxable.

Gifts are made by a relatively simple document assigning the LLC membership interest to the donee. Gifts of LLC interests to minors (e.g., grandchildren) can be made to a custodian (e.g., a parent) under the North Carolina Uniform Transfers to Minors Act (UTMA). The LLC interests themselves are similar to the shares of stock in a corporation. They represent a right to share in the income and capital of the LLC. Non-manager LLC interests have no management rights in the LLC, which means that the holders of non-manager LLC interests have no right to control the assets in the LLC. Only holders of manager interests have such control. Your mother, as holder of the manager LLC interests, would have those rights. As the LLC manager, your mother would control the LLC assets and the flow of income to the members. Although non-manager LLC members are entitled to a proportionate share of distributed LLC income, the manager decides how much LLC cash or property is distributed each year. In addition, the Manager is entitled to reasonable compensation for managing the LLC.

To preserve ownership of the LLC within the family, the sale or transfer of these interests can be restricted so that no one can sell the gifted interests, and the LLC interests can be protected from other transfers such as those arising from a divorce. Restrictions such as these, along with restrictions and limited liability granted under state law, can provide significant creditor protection. Unlike a partnership, in which all liability for partnership debts is placed upon the general partner(s) personally, all members, including the Manager, of an LLC have limited liability for the debts of the LLC.

Unlike a corporation, in which a creditor can seize a debtor's stock, a creditor cannot seize the ownership interest in an LLC. Creditors seeking to satisfy a judgment against a member of an LLC for a debt unrelated to the LLC (e.g., personal injury judgment or a medical malpractice judgment) are limited to a "charging order" against the LLC member's interest. The charging order provides that any LLC property which becomes distributable to the debtor member must be paid instead to the creditor to the extent of the unsatisfied judgment. Remember, however, that the children and grandchildren are not in control of how much LLC cash or property is distributed. The creditor will have to wait until the Manager decides to make a distribution to the debtor member. This can provide significant leverage for settlement.

For a simplified example of family LLC planning, let's assume that Mom has transferred assets valued at $1,000,000 to a newly formed LLC. A qualified business valuation expert has determined that the gifted LLC interests should be discounted 25% from the underlying asset value. Ten annual exclusion gifts of 1.33% FLLC non-manager interests worth $10,000 each are made. With the 25% discount, the asset value underlying each of those gifts is $13,333 for a total of $133,333. Mom now holds an 86.67% interest in the FLLC. That interest is not worth $866,666, but something less -- say, that amount reduced by a 15% discount for lack of marketability, making that interest worth $736,000.

In one fell swoop, by using the FLLC, the estate has been reduced by $264,000, versus reducing it by $100,000 if no FLLC was used and annual exclusion gifts of the securities were made directly. Were your mother to pass away this year, that difference of $164,000 could save her estate $65,000 in estate taxes. The same thing can be repeated the next year, or Mom can make gifts of more than the annual exclusion amounts, keeping in mind that this will require using some of her lifetime exemption, and may require the payment of some North Carolina gift tax.

As sophisticated estate planning vehicles, family limited partnerships and family limited liability companies are not inexpensive. Initial costs, including attorney's fees, real estate transfer costs, and appraisal fees generally range from $10,000 to $20,000 or more. In addition, there are ongoing maintenance fees, such as accounting fees, tax return preparation fees, management fees, etc.

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