TA K E N OT E

Recent developments in estate, business and tax planning

Special Issue August, 2008

(Revised from September, 2005)
Triple Leveraged Family Limited Partnerships
Jerry Weihs, JD, CPA, MBA, CLU, ChFC and Douglas Bowden, CLU, ChFC
INSIDE THIS ISSUE
Triple Leveraged Family This article will demonstrate the significant leverage that can be achieved by the
Limited Partnerships utilization of Family Limited Partnerships (FLPs) along with life insurance acquired
via premium financing techniques. Significant discounts can be achieved by the
Advanced Markets Group
800-432-1102 transfer of assets to a FLP. Often this will be in the 30 - 40% range. Placing substan-
tial amounts of life insurance in the FLP gives an opportunity to leverage the death
Advanced Markets Attorneys benefit at a multiple of the premiums paid while still getting the discount applica-
Janice Alexander Forgays, Esq., CLU
ext. 1846 ble to the FLP. In addition, the use of premium financing techniques will signif-
janice.forgays@sunlife.com icantly reduce the outlay necessary to fund the life insurance, with favorable internal
Jerry Weihs, JD, CPA, MBA, CLU, ChFC rates of return and without the need to liquidate other assets to pay premium. These
ext. 1756 three types of leverage will significantly increase the amount of assets passing to the
jerry.weihs@sunlife.com next generation, reduce estate taxes and do so in a cost effective manner.
Deborah Moon, Esq., CLU FLPs can protect the family wealth, provide a tool for reducing estate taxes and
ext. 1838 still permit a measure of control over the assets of the FLP. The partnership must
deborah.moon@sunlife.com
have a valid business purpose under state law. The FLP must also conform to
Rose Watson, Esq. recent case law to withstand IRS scrutiny.
ext. 7196
Rose.Watson@sunlife.com Typically, the older generation (i.e. the parents) will establish the FLP and fund it
Advanced Case Design with their assets. The parents will be issued the General Partner (GP) interest and
Douglas Bowden, CLU, ChFC Limited Partnership (LP) interests in exchange for the assets contributed. The parents
ext. 2450 often retain the GP interest to maintain voting control over the FLP and will then gift
douglas.bowden@sunlife.com the LP interests to the younger generation (i.e. children) over a period of time.
Greg Faux LP interests cannot have management responsibilities and cannot be liquidated
ext. 1817
greg.faux@sunlife.com without the consent of the GP, nor can they be freely sold or transferred. This
lack of control and marketability causes the LP interests to have a discounted
©2008 Sun Life Assurance Company of Canada. value. The ability to apply discounts to gifts of LP interests is a substantial benefit
All rights reserved. Sun Life Financial and the globe to the family and is often the primary factor for establishing the FLP. It is important
symbol are registered trademarks of Sun Life that a qualified appraiser establish the valuation of the FLP, as well as determine
Assurance Company of Canada.
the applicable discounts.
All guarantees are based on the claims-paying ability
of Sun Life Assurance Company of Canada (Wellesley BENEFITS OF ARRANGEMENT: THE FIRST LEVERAGE
Hills, MA), or in New York, Sun Life Insurance and To reduce the size of the gross estate without giving up control of the underlying
Annuity Company of New York (New York, NY). property held by the FLP is the major goal to be achieved. The GP retains manage-
Not FDIC/NCUA insured. May lose value. ment control while holders of the LP interests cannot participate in management.
No bank/credit union guarantee. Not a deposit.
Not insured by any federal government entity. Continued on page 2

FOR PRODUCER USE ONLY

NOT FOR USE WITH THE PUBLIC
 Triple Leveraged Family Limited Partnerships
In addition, protection of assets can be achieved
against third party creditors.
Valuation discounts are available when the parents
transfer the LP interests to their children by making
gifts of the discounted LP interests. While the value
of the gift is its fair market value (FMV) on the date
of transfer, a discount is applicable due to the lack of
marketability and no management control, as well as
other applicable valuation discounts. The net result
is that FMV of LP interests are less than the under-
lying property held by the FLP.
Once LP interests have been gifted, they are
excluded from the transferor’s estate. Therefore,
any appreciation on those LP interests will not be
taxed in the transferor’s estate. In addition,
income distributed to Limited Partners will be
taxed at their respective income tax rates which will
often be lower than the General Partners tax
bracket.
A FLP offers asset protection as well. In most states,
a creditor can obtain a “charging order” against a
properly structured FLP. This gives the creditor
assignee status, but without the right to demand a
distribution of income or assets. The GP maintains
control over all distributions and cannot be forced
to make one to satisfy creditors.
The type of property interests transferred to a FLP
may vary. The best type of assets for transfer
would be closely-held business stock, marketable
securities and unencumbered real estate. Remem-
ber, there needs to be a business purpose for
setting up the FLP.
VALUATION DISCOUNTS
 Lack of marketability: A buyer would pay less for
a LP interest than the proportionate value of the
underlying property because it is difficult to sell
the LP interest (no readily available market for
LP interests).
 Lack of control (minority interest): A buyer
would pay less because, without control, the LP
is unable to compel a liquidation of their inter-
est in the underlying property.
INTERNAL REVENUE SERVICE VIEW
Because of all the benefits associated with FLPs,
they have come under fire from the IRS for being
merely a device to avoid paying estate taxes while
letting the senior family members retain control
over their assets. Potential red flags for the IRS
include:
2 FOR PRODUCER USE ONLY
Continued from page 1
transferring a large percentage of the taxpayers’
assets to the FLP
putting a primary residence and other personal
assets into the FLP
establishing a FLP right before death
failing to distribute earnings to the LPs
personal expenses paid directly by the FLP
Ways to improve the chances of withstanding IRS
review:
Be sure the FLP is run as a business, not as a tax
avoidance scheme
Grantor cannot retain too great of control over
the assets transferred
Maintain adequate assets outside of the FLP to
cover the normal living expenses of the creator of
the FLP
Document the reasons for the creation of the FLP,
for example, cost-saving features such as reduc-
ing investment management fees by the pooling
of assets
SECTION 2036 ARGUMENT
The essence of the IRS argument is that the way the
FLP was either structured or operated, the grantor ef-
fectively retained the possession or enjoyment of the
property transferred to the FLP and so the FLP assets
are in the grantors estate for tax purposes. The appli-
cation of Sec. 2036 has come down to whether non-
tax reasons existed for the creation of the FLP and
whether the taxpayer respected the entities’ integrity.
The recent case of Strangi vs. Commr appears to
reflect an evolving consensus on the application of
Sec. 2036 to the FLP area. The Fifth Circuit Court of
Appeals held that assets transferred two months
prior to death to a FLP were includible in the grantors
gross estate. The inclusion was a result of: 1) the
decedent retaining an implied interest in the trans-
ferred property and; 2) the transfer was not a “bona
fide sale” for full and adequate consideration in that
it was not motivated by substantial non-tax reasons.
USES OF LIFE INSURANCE IN FLPs:
THE SECOND LEVERAGE
The FLP can be an attractive alternative to an Irrevo-
cable Life Insurance Trust (ILIT). While the proper
utilization of an ILIT will remove 100% of the value
of the insurance proceeds from the grantor
insured’s estate, in the case of the FLP, the partner
insured’s retained partnership interest will result in
inclusion commensurate with the FLP units owned.

ADVANTAGES OF PARTNERSHIPS
A partnership is governed by state statutes and
contract law which offers greater flexibility and
control to the insured. An ILIT is an inherently inflex-
ible document while a partnership agreement is a
flexible, contractual arrangement. In other words, the
FLP may be changed by agreement of the partners
The limited partnership allows the insured continued
participation, as a General Partner, in the administra-
tion of partnership property without jeopardizing
estate tax planning goals. The tax effects of a FLP
owning life insurance can be very positive. The
proceeds are received income tax free (Sec.101(a)).
The partner’s basis is increased by the distributive
share of partnership tax-exempt income, Sec
705(a)(1)(B), which insures that the proceeds retain
its tax-exempt character.
Any proceeds payable to the FLP on the death of the
insured, when the policy was owned and paid for by
the FLP, should not be includible in the insured’s
estate, except for the corresponding increase in the
value of the percentage ownership of the insured (i.e.,
if the insured is a 10% owner, that percentage of the
proceeds will be reflected in the FLP valuation). The
partnership will have a greater ability than an ILIT to
pay premiums without causing taxable gifts because
there are no “Crummey” powers and “5 and 5” rule
limitations. FLP assets and income from those assets
are available to make premium payments.
The transfer of a life insurance policy to the FLP will
not be a transfer for value as the insured would be a
partner, an exempt transfer pursuant to 101(a), nor
would there be a three year problem under
Sec.2035 if the policy was contributed to the FLP for
adequate consideration, again, an exempt transfer.
Finally, if the partnership is both policyholder
and beneficiary, the insurance proceeds are not
directly includable in the insured partner’s gross
estate. Estate of Knipp. Proceeds received by the part-
nership will be included with the other partnership
assets in determining the value of the decedent’s
partnership interest for estate tax purposes. However,
if the insured had personal incidents of ownership
in the policy, such as the right to change the benefi-
ciary, the entire value of the proceeds would be
includable in his gross estate. Hall vs. Wheeler.
Therefore, it would be good planning to make
clear in the partnership agreement, that a partner is
prohibited from participating in the exercise of any
incident of ownership with respect to a partnership-
FOR PRODUCER USE ONLY
TA K E N OT E
held policy insuring his or her life.
It is imperative that the rationale of Strangi be
followed when placing substantial amounts of life
insurance in a FLP. Indeed, if the transferor of the
property retains too great an interest in the FLP
assets or fails to demonstrate sufficient non-tax
reasons for the formation of the FLP, the goal of
removing assets from the transferor’s estate will fail.
It will increase the assets includable in the gross
estate, exactly the opposite of what is intended.
WHERE WE ARE
At this point we have achieved two levels of leverage.
The first was the ability to take discounts of approx.
30% on the transfer of assets to the children. The
second is the placement of substantial amounts of life
insurance in the FLP. We achieve this leverage two
ways: by the face amount of insurance being a multi-
ple of the premiums paid, thereby increasing FLP
assets, while at the same time subjecting the FLP units
to the discounts for lack of control and marketability.
PREMIUM FINANCING: THE THIRD LEVERAGE
The third and final use of leverage will be the appli-
cation of premium financing to the acquisition of
the life insurance. The assets of the FLP will enable
us to acquire large amounts of life insurance on a
cost efficient basis.
Premium Financing is a technique designed for
individuals who have a life insurance need but do
not wish to liquidate assets to fund the life insur-
ance policy. An individual will take out a loan from
a third party lender to pay premiums on a life insur-
ance policy. The life insurance company is not a
party to this transaction.
The borrower will apply for a policy and once it has
been underwritten, the borrower will apply to the
third party lender for financing and the terms of the
loan will be finalized. The third party lender will set
the spread and the payment schedule for the loan. The
lender will also require collateral for the loan; in most
instances it will be the policy cash value and additional
collateral. In essence, by paying the interest via the
cash flow of the FLP the premiums can be financed.
Premium Financing may be a solution for those
individuals who feel that they earn a rate of return
that is in excess of the interest rates that are being
charged by the lender. Also those clients whose
assets are “illiquid” and are tied up in business or
real estate may also find this technique appropriate.
The premium financing outlay is the interest due on
Continued on page 4
3
 TA K E N OT E
Triple Leveraged Family Limited Partnerships Continued from page 3

the loan. This can often be less than the cost of continuous pay premium of $165,687 is selected to
the premium. coordinate the lowest borrowed premium each year
Premium Financing can be best explained by the to minimize the out-of-pocket costs, which is loan
use of an example. Assume we have John, age 68 interest due each year. The initial loan rate will be at
and 68, who has three children and a net worth of 7.0%1 and interest will be paid in arrears. The table
$7.5 million. His assets include commercial below summarizes how the numbers will look.
properties with a market value of $1.3 million. The key numbers for comparison purposes is the
The income from these properties generates 8% Internal Rate of Return (IRR) which demonstrates
annually and appreciates at 7% annually. the efficiency of premium financing over non-
John transfers properties to a FLP in exchange for a financed insurance. In addition, the difference
1% GP interest and a 99% Limited Partnership between the annual outlays for financed insurance
interest. John will then utilize his $1 million lifetime vs. non-financed insurance can be invested in the
gift exemption to transfer the Limited Partnership FLP’s assets to further increase the value.
interests to his children gift tax-free employing a CONCLUSION
30% valuation discount which reduces the $1.3 We have demonstrated how to achieve triple lever-
million to $1 million for gifting purposes. John age with the FLP by:
will retain the General Partnership interest and Reducing the taxable estate by transferring
maintain control over the assets. Only the 1% Limited Partnership interests at a discount to the
General Partnership interest will be includible in children
his estate. The FLP then purchases a $3.75 million
life insurance policy on John. Purchasing life insurance inside the FLP to
further increase FLP assets from $1.3 million
HOW IT WORKS to $5.05 million. Only the General Partnership
The annual income generated by the properties is interest of $50,500 (1% of $5,050,000) will be
approximately $104,000, which is more than includable in the estate.
enough to purchase a $3.75 million Sun Universal
Leveraging the life insurance purchase by utiliz-
Protector® with a lifetime guarantee at an annual
ing a premium financing strategy allowing the
premium of $94,636. They have decided to leverage
FLP to reinvest or distribute annual income to
the life insurance by using a premium financing
respective interests.
strategy. The FLP will purchase a $3.75 million Sun
Universal ProtectorPlus with a Return of Premium The end result is that a significant percentage of an
death benefit option. This will allow for both the estate can be transferred outside the taxable estate
repayment of the loan at John’s death and provide and can be leveraged to grow those assets for the
the FLP with a net death benefit of $3.75 million. A benefit of future generations, as long as appropri-
ate IRS guidelines are followed.
Year Annual Outlay (Loan Annual Outlay Net Death Death Benefit IRR for IRR for
Interest Due at 7.0%) for Non-Financed Benefit for for Non-Financed Financed Non-Financed
for Financed Insurance Insurance Financed Insurance Insurance Insurance Insurance
1 $0 $94,636 $3,750,000 $3,750,000
5 $46,392 $94,636 $3,750,000 $3,750,000 262.99% 79.29%
10 $104,383 $94,636 $3,750,000 $3,750,000 51.08% 24.17%
15 $162,373 $94,636 $3,750,000 $3,750,000 19.11% 11.41%
20 $220,364 $94,636 $3,750,000 $3,750,000 7.09% 6.14%
This illustration must be accompanied by a basic illustration displaying values on the same premium outlay and assumptions, and
prepared on the same date as this illustration. Please see the basic illustration for guaranteed elements and other important information.
This is to be used with traditional premium financing programs only.
1
The loan interest rate is fixed for a 1 year term and will rollover on each anniversary to a rate based on the one year LIBOR in effect at that time.
This information is intended to be of a general education nature. Sun Life Financial and its independent distributors do not give legal, tax or accounting
advice. For specific tax or legal advice seek and rely on a qualified tax advisor or attorney. Sun Life Financial and its distributors specifically disclaim any liability
or loss which is incurred as a consequence, directly or indirectly, of the use of this program.
4 FOR PRODUCER USE ONLY
SLPC 19243 08/08 NOT FOR USE WITH THE PUBLIC