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Monday, April 29, 2024
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Case Studies |
Double Your Discount, Leverage Your Gift
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Case:
Ralph and Virginia Thompson, both age 65, own a number of business assets which they would like to transfer to their three children. One of the business assets is stock in a closely held "C" corporation that the Thompsons started 15 years ago on a shoestring and now is worth $2.5 million. The three children all work for the corporation and are minority shareholders. Ralph and Virginia have been utilizing their gift exclusions to transfer shares to the children over the past seven to eight years and have been able to transfer $500,000 of value to them. However, they desire the complete ownership of the company to be transferred to the children within the next few years.
In a recent meeting with their estate planning attorneys, they were told that one way to transfer the stock to the children is through a family limited partnership (FLP). As was explained to them, an FLP is typically a partnership with a 1% general partner, quite often a corporate general partner, and 99% limited partners. By setting up an FLP and gifting limited partnership interests to the children, there are substantial discounts available for gift tax purposes because of lack of marketability and lack of control. Using these discounts, sometimes as high as 40%, it is possible to gain a very highly leveraged gift through the use of the FLP.
Question:
Transferring the limited partnership interests to the children - even with a 40% discount on the $2 million of value - would still result in a gift to the children of $1.2 million. Is there a method whereby the gift to the children can be discounted even further? Is there a way to couple the gifting to the children with a charitable gift, since Ralph and Virginia have been asked to make a five-year pledge of $1 million to their local hospital's capital campaign?
Solution:
In discussing their objectives with the Director of Gift Planning at their local hospital, Ralph and Virginia were pleased to learn that by coupling the FLP with a charitable lead trust, they could realize both of their objectives. Through the use of leverage in both agreements, it is possible to use a lead trust to move the stock to the children at deep discounts. In order to do so, it is necessary to create a lead trust that lasts for less than five years. Under Internal Revenue Code Sec. 4947(b)(3)(A), if a lead trust is created in which the charitable deduction is more than 60% of the trust's aggregate fair market value, the trust must not last for more than a period of five years. If the five-year period is exceeded, the excess business holdings provisions under Sec. 4943 would apply. Fortunately, under Sec. 4943(c)(6) there is a five- year "grace" period to dispose of gifts.
Therefore, it is possible to create a charitable lead trust with a fairly high payout and deduction that will pass to family members in less than five years.
Ralph and Virginia decide to transfer the stock first to an FLP. The initial value of the stock is $2 million and the dividend yield on the stock is currently 10%. As a result of the expert appraisal and discount of 40%, the asset is now reduced in value to $1.2 million. Therefore, the effective return is now 16.67% ($200,000 divided into $1.2 million = 16.67%). The FLP limited partnership interests are then transferred into a lead trust of 4.99 years (less than five years). The payout rate on the lead trust is 16.67% on the value of $1.2 million. Upon termination of the lead trust, the limited partnership interests are transferred to the three children.
Ralph and Virginia are very pleased with this scenario. The lead trust will pay the million dollars to the hospital over the five-year period, thus fulfilling their pledge. Taking both "discounts" into sccount, the taxable gift to the children is only $363,872. A gift tax return would be filed by Ralph and Virginia, but no gift taxes would be due since their lifetime exemptions are available and would simply be reduced by the amount of the taxable gift. Therefore, through the combination of the FLP and charitable lead trust, they are able to leverage their exemptions and transfer $2 million of value at a discount of 82%.
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