Now is the Time to do Some Reverse Estate Planning by Jeffrey M. Mutnik, CPA/PFS
For decades, families with moderate-to-high net worth have employed a variety of tried-and-true estate-planning techniques to protect assets, transfer wealth to future generations and minimize their income and estate tax liabilities. However, with the changes to the tax laws that went into effect beginning in 2018, a strategy that worked as recently as last year may not achieve the same intended goals and objectives in the future. For example, the recent doubling of the federal estate tax applicable exclusion amount to $11.18 million for an individual, or $22.36 million combined for married couples, provides families with a window of opportunity to reconsider the current and future application of their existing estate-planning tools.
The use of family limited partnerships (FLPs) as a viable estate-planning tool has become ubiquitous as older generations live longer, the stock markets surge forward, and the equity taxpayers have built up in their homes has turned into substantial real estate investment assets. FLPs are legal structures in which families typically hold appreciated assets, including, but not limited to, portfolio investments and real estate. The FLP itself is not subject to tax on the assets it holds. Rather, the FPL’s partners report on their income tax returns their annual share of the entity’s income and deductions in proportion to the interest they hold. Whereas general partners (GPs) have complete control over how an entity manages and invests its assets, limited partners (LPs) hold a minority, non-controlling stake in the partnership and therefore qualify to receive a discount on their interest in the pro-rata value of the partnership’s underlying assets. Taxpayers may leverage this lack of marketability and control over FLP interests by conducting one or more transactions to convert direct ownership of select assets into indirect ownership of those assets through LP interests or non-managing limited liability company (LLC) interests. Depending on the structure, this reduction in the value of the limited partners’ interests could even eliminate their gift and/or estate tax liabilities.
The transfer of assets to a limited partnership also allows for centralized management of those assets and provides LPs with the benefit of asset-protection from potential future creditors, both of which become more important as the elder family members continue to live longer. Despite these benefits, the transformation of ownership interest does have one significant income tax-related drawback: lower tax basis of the inherited LP interest. When LP die, instead of passing their original assets at their full date-of-death value, they pass their discounted LP interest to named beneficiaries, whose tax basis will be the discounted date-of-death value of such interest. Consequently, beneficiaries will most likely not be able to liquidate a decedent’s assets without an income tax consequence.
Before the tax code allowed decedents to pass their unused estate tax exemption to a surviving spouse, most families were more concerned with receiving a discount to reduce the value of their taxable estates than a lower basis of those inherited assets. However, this concept of portability combined with the increase in the estate tax exemption between 2018 and 2025 should persuade families to review, rethink and even reverse some, or all, aspects of their existing estate plans.
As an example, consider what would happen if the LP interest became a GP interest. Could the risk of potentially losing asset protection be outweighed by the potential increase of the basis inherited without a discount? Individuals must consider a myriad of factors when reviewing their estate plans under the new tax laws, including, but not limited to federal and state-level estate tax, income tax and other taxes to which individuals may be exposed. If a family has enough assets they want to preserve, but not enough to trigger a federal estate tax liability, it is appropriate that they question whether their current estate plans continue to achieve their short- and long-term goals.
The advisors and accountant with Berkowitz Pollack Brant have deep experience navigating treacherous tax laws and developing comprehensive estate plans tailored to meet the unique challenges and needs of U.S. and multinational families.
About the Author: Jeffrey M. Mutnik, CPA/PFS, is a director of Taxation and Financial Services with Berkowitz Pollack Brant Advisors and Accountants, where he provides tax- and estate-planning counsel to high-net-worth families, closely held businesses and professional services firms. He can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at email@example.com.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.