New IRS Regulations Eliminate the Ability to Discount the Value of FLP and LLC Gifts to Family Members

This month, the IRS finally issued proposed regulations that will eliminate (or severely limit) the ability to discount the value of transfers of interests in closely held entities (FLPs, LLCs, family corporations) to family members.

Such “leveraged gifting” has been an extremely important and common method used by estate planners to eliminate estate taxes.

The proposed regulations will undergo a ninety day comment period and a public hearing on December 1, 2016. Shortly after that the IRS will publish final regulations which will take effect within thirty days after publication.

These proposed regulations were expected.  We have previously written about them here and here.

While we do not venture into political discussion, we point out that Hillary Clinton has stated that she will reduce the estate tax exclusion from $5,450,000 per person ($10,900,000 for a married couple) currently in effect, to $3,500,000 per person ($7,000,000 for a married couple) and reduce the gift tax exemption from $5,450,000 per person to $1,000,000 per person.  She will also increase the gift/estate tax to 45%.  (Donald Trump has proposed to eliminate the gift/estate tax entirely.)

Readers who have not yet completed their estate planning are strongly urged to contact us to implement gifts of FLP and LLC interests to their heirs before the changes take effect.

Please see our related articles:

Family Limited Partnerships & Discounting

Historic Opportunity to Avoid Tax on Over $10 Million+ of Assets

Year-End 2015 Tax Planning: Take Advantage of Gifting to Lower Estate Tax – Before the Law Changes

LLC/FLP Discounting and Leveraged Gifting to Lower Estate Tax May Soon Be Limited

Please contact us with any questions.

New Opportunities for Ownership of Co-op Apartments by Family Limited Partnerships & Trusts

Many residential apartments are owned by cooperative corporations (“co-ops”).  In New York City, it has been estimated the coop apartments outnumber condominium apartments by three to one.  The boards of directors of co-ops have been known to be especially and unreasonably restrictive as to who they will admit as shareholders and residents, and many boards, especially in New York, have acquired reputations of being “snooty” and exclusive.  The pop singer Madonna was famously rejected by the co-op board of a very expensive Park Avenue building.

The Wall Street Journal reports (“Co-ops Get Competitive”, August 29, 2013, page A-17) that the boards of cooperative apartments are now relaxing their policies and acceptance criteria in order to appeal to younger buyers, as well as to foreign buyers, who are not willing to put up with onerous admission requirements and unreasonable restrictions.  These co-op boards are changing their policies in order to be competitive with condominiums and in order to attract new investment and new buyers.

What does this have to do with asset protection and tax minimization?

First, one’s home, whether a co-op, condo, house or otherwise, is normally a very significant asset and should be protected from future claims.

As the Wall Street Journal points out, “while buyers have always been able to buy condos and townhouses anonymously under corporations and trusts, now even some Fifth Avenue [co-op] boards have let brokers know that they would now consider purchases done in the names of trusts or limited liability companies . . . .”  And, we would expect, in the names of family limited partnerships (FLPs), which are similar to limited liability companies (LLCs) but offer better asset protection.  Thus, ownership of a co-op by an FLP is advisable if allowed by the co-op board.

Second, as noted above, co-op boards are positioning themselves to take advantage of the healthy demand by wealthy foreign buyers for U.S. real estate.  As the Wall Street Journal reported, co-op boards have clarified their rules, and made “it clear that international buyers, who are active in the condo market, were welcome” at co-ops as well.  We have written before about the appeal of U.S. real estate, especially expensive apartments, to wealthy foreign buyers.  We have also discussed how, through the use of certain hybrid trusts, foreign buyers can minimize their exposure to the Foreign Investment in Real Property Tax Act (“FIRPTA”), which imposes an onerous 10% tax on the gross sale proceeds when a foreign owner sells U.S. real estate.  Please see our article, How Foreign Purchasers of U.S. Real Estate Can Save Significant Taxes.

As co-ops attract new buyers, domestic and foreign, it is important to consider the best form of ownership of real estate.  Ownership in entities such as FLPs and trusts may offer significant asset protection and tax benefits.  Please contact us for additional information.

Protecting Business Interests: How to Protect Subchapter S-Corporations?

Protecting Business Interests: How to Protect Subchapter S-Corporations?

Your most valuable asset is very likely your ownership interest in your business; it is the primary source of your future income.  Protecting your ownership interest in your business from future personal creditors is a paramount consideration in an asset protection plan.  A business which operates as a sole proprietorship offers no asset protection whatsoever.  Membership interests in an LLC, and shares of stock in a C-Corporation, can be conveyed to a Family Limited Partnership (FLP) for additional asset protection.

If you own shares in a Subchapter S-Corporation, however, these shares cannot be protected.  The Internal Revenue Code (IRC) only allows for shares of an S-Corp to be owned by individuals.  IRC §1361(b).  Thus, entities such as FLPs may not own shares in an S-Corp.  FLPs can own shares of a C-Corp or an LLC.

There are two ways to handle S-Corp shares within the context of asset protection.  One way is to transfer the S-Corp shares to an FLP and allow the S-Corp to default to a C-Corp. Alternatively, you could re-organize the S-Corp into an LLC, and then protect the LLC membership interests within an FLP.

An S-Corp should not default to a C-Corp if either of the following two concerns are present:

  1. If the S-Corp owns appreciated assets (such as appreciated real estate), the IRS will treat the default as a sale of those assets (from the S-Corp to the C-Corp), subject to capital gains tax.
  2.  C-Corps have an inherent “double taxation” issue:  First, the C-Corporation pays corporate tax on its profits.  Second, when the C-Corporation distributes the remaining profits as dividends to its shareholders, the shareholders pay income tax on the dividends received.  The double tax issue would not exist if the C-Corporation can issue bonuses to its shareholders/employees, which would be deductions to the C-Corp and thus “zero out” its profits.  However, if these bonuses are excessive, there is a danger that the IRS would deem the bonuses to be disguised dividends.

If these two situations cause concern, the S-Corp should re-organize as an LLC, rather than default to a C-Corp, and the membership interests in the new LLC may then be protected within an FLP.

An S-Corp may be re-organized, on a tax-free basis, into an LLC.  This re-organization is a change in form of ownership.  IRC § 368(a)(F).  The business operations of the S-Corp, now an LLC, remain unchanged.  Both LLCs and S-Corps are “pass through” tax entities, i.e., the entities themselves pay no tax; rather, the gains or losses “pass through” to the members of the LLC or shareholders of the S-Corp.  (Thus, the “double taxation” issue of C-Corporations, discussed above, is avoided by both S-Corps and LLCs.)   The “flow through” status of the S-Corp, now re-organized as an LLC, remains unchanged.   In addition, there is no deemed sale of assets and resulting capital gains tax consequences, as there may be if an S-Corp defaults to a C-Corporation.  IRC § 354(a).
Qualified tax counsel can prepare the documentation necessary for an S-to-LLC reorganization, complying with the proper tax laws and regulations.  This must be done carefully, lest the IRS consider the reorganization to be a “conversion” of S-Corp to LLC, which would result in negative tax consequences.  The following steps must properly occur:

a.  An actual “reorganization” must take place;
b.  There must be a valid business purpose;
c.  There can be no change in the nature of the taxpayer’s capital position;
d.  There must be a continuity of interest and control;
e.  There must be continuity of business enterprise;
f.  There must be a plan of reorganization.

If the S-Corp becomes an LLC in accordance with the steps specified above, the transaction will qualify as a “reorganization” under the Internal Revenue Code, and will be tax-free.

After a proper S-Corp to LLC reorganization, the LLC membership interests may be conveyed to an FLP.  Once within an FLP, the LLC interests will be protected from future creditors.

 

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