Heckerling
Institute 2005
Reports from the event, as
posted to the ABA-PTL List Serve |
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This Report contains additional coverage of the Monday A.M. Fundamentals
program and coverage of one of the four Tuesday morning general
sessions.
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Monday, 1/10/05 - FLPs and LLCs from A to Z Louis
A. Mezzullo Esq.
Report by Shelly D. Merritt Esq.
Mr. Mezzullo gave a comprehensive presentation on issues relating
to family limited partnerships and LLCs. He first addressed what
type of entity to use for a family entity. It generally comes down
to either a limited liability partnership or limited liability company.
For several reasons stated throughout the presentation, Mr. Mezzullo
prefers LLCs if the applicable state statute meets certain requirements
discussed below.
He pointed out that the nature of the assets affects the type of
entity to use. For example, if the client has an active business,
it may be preferable to use an S-corporation in order to be able
to treat some income as dividend income to avoid the additional
2.9% self employment tax.
Characteristics of an interest in an entity affecting discount
on value:
1. Management rights add to value, lack thereof decreases value
2. If a member/partner has the right to require the entity to buy
his
or her interest at any time, this also adds to value, lack thereof
decreases value.
3. If a member/partner can transfer freely, adds to value, lack
thereof decreases value.
Tax issues
1. Qualifying a transfer of an interest in an entity for annual
gift
tax exclusion. Hackle case involved LLC with no steady stream of
income. Court held that where donee could not transfer full membership
interest to a 3rd party, a gift of the interest doesn’t qualify
for annual exclusion. To avoid Hackle, Mr. Mezzullo suggests providing
in the operating agreement that a member/limited partner can transfer
his or her full ownership interest to 3rd party after first offering
to the company/partnership (i.e., the transferee receives full membership/limited
partnership interest instead of assignee interest). This does not
affect discount much, if any, since the membership/limited partnership
interest has no voting rights.
2. IRC §2036(a) Issues. Kimbell v. U.S., 244 F. Supp 2n 700,
91 AFTR
2d 2003-585 (N.D. TX 2003) and Estate of E. Stone III, T.C. Memo
2003-309 both held that 2036(a) did not apply to the initial transfer
to the partnership since the transfers fell within the bona fide
sale exception to
2036(a). Both found non-tax reasons for the entity. He advised that
it
is best to have other owners own non- deminimus interests in the
entity when the decedent dies in order to avoid IRS argument that
the only reason the entity was set up was to avoid tax (i.e. where
decedent owns almost all LP interest and child owns small GP interest
at death).
3. IRC §2036(b): If a transferor retains the right to vote
stock that
is transferred to an FLP, the value of the stock will be included
in the
transferor’s estate. This is the rule under Bynum. Two options
for
avoiding this result: 1) With respect to voting rights, provide
that all members/partners of the entity can vote the stock in proportion
to their ownership interest in the entity, or 2) Have another entity
own the right to vote the stock, not the family members.
4. IRC §2701: Provides that if an older family member transfers
an
interest in an entity to a younger family member and the transferor
retains a senior or preferred equity interest, then special valuation
rules apply causing the gift value to be increased.
a. Can be avoided if there is only one class of equity interest.
b. If there is more than one class of equity interest and the retained
interest is a “qualified payment right,” then right
can be taken into account in valuing the transfer to the lower generation
to decrease value. But, if payments are not actually made, then
you have a problem.
5. IRC §2703: Provides that any restrictions (that are not
commercially reasonable) on right to transfer an interest in an
FLP are ignored when determining the value of the interest.
a. Transfer restrictions typically used in FLPs are generally
commercially reasonable because same restrictions would be used
with non family members.
b. Several cases have held that §2703 does not apply to disregard
the
entity altogether.
6. IRC §2704(a): Provides that a lapse of a voting or liquidation
right results in a taxable gift if during the transferor’s
lifetime or in an increase to the estate of the transferor, if at
death. For example, if an older family member is a GP and the GP
interest is converted upon his/her death to a LP interest, the dimunition
in value of the interest is added back.
a. Have a corporation serve as the GP to void application of
2704(a). No death, no lapse.
b. If state law provides that GP’s withdrawal causes dissolution
of
partnership, then this section applies.
c. Will not apply where manager of an LLC dies because death of
member
in an LLC does not cause dissolution of the LLC. One argument in
favor of
using LLCs instead of LLP.
7. IRC §2704(b): Applicable Restriction (a limitation on the
right of
an owner to liquidate his or her interest, if the restriction is
more restrictive than state law) is ignored for valuation purposes.
There are cases that provide that an Applicable Restriction is only
the right to dissolve the entity, not just the member’s/partner’s
interest in the entity.
Non Tax Reasons for Having FLP
1. Limited liability to members/partners
2. Retention of control
3. Continuity of life
4. Restrictions of transferability
5. Use as management company for other business entities
6. Restrictions on management and voting rights
7. Protecting assets from liability
8. Protecting assets from owner’s creditors (creditors can
only get
charging order, if creditor goes after interest, becomes assignee
and must pay tax on income attributable to interest). Keep property
as separate property for marital property purposes.
9. Dealing with recalcitrant family members. Provide for arbitration
in agreement, payment of legal fees if challenge, etc.
10. Desirable tax characteristics: (Very important to convey to
clients
that entity is not all about taxes)
a. Partnership tax treatment
b. No restrictions on ownership (s-corps have restrictions)
c. No restrictions on capital structure
d. Tax Free formation - tax free incorporation more
complicated than formation of partnership. Corporation - owners
transferring assets to form corporation must own at least 80% after
formation.
e. Tax free contributions
f. Tax free withdrawals
g. Basis step up. Partnerships are allowed to make 754
election to step up inside basis on assets owned by partnership.
Corporations can’t do this.
Downside to FLP planning, children have lower basis due to gifts
(carryover
basis) and discounts on parents’ deaths. (See examples in
appendix)
Formation of Entity Issues
1. If have validly formed partnership, can make gifts from the
very
beginning immediately after formation.
2. If put something like a vacation home into the entity, it may
be
better to put into an LLC if the state LLC act does not require
it to have a business for profit. A partnership is by definition
a business of more than one person for profit.
3. Investment Company Issues. Causes recognition of gain upon
transfer to entity of appreciated property to entity.
4. Contributions of property subject to liabilities can cause gain.
5. Family partnership rules - Capital must be income producing factor
and donee must have economic interest in partnership/LLC. If don’t
satisfy these rules, income of partnership is reallocated to the
senior family members.
Income Tax Issues When Dissolving or Making Distributions from
Entity
1. Generally, a partner only recognizes gain in connection with
a
distribution from the partnership to the extent that any money (marketable
securities are treated as money) distributed exceeds his or her
basis in the partnership. There are several exceptions to the general
rule.
2. Exception: If appreciated property is contributed to a partnership
and then distributed to another partner within 7 years, donor must
recognize the built in gain on the property. Same is true if other
property is distributed to the donor partner within 7 years.
Drafting Issues
Provisions in agreement to focus on:
Allocation of profit and loss
Allocation of distributions
Restrictions on transfers
Events causing dissolution
Voting and management rights
1. Need to know default provisions in state statute. IRC
§2704(b): If agreement is more restrictive than default rules,
then have applicable restrictions.
2. Articles of Organization should provide the following:
a. Provide whether member or manager managed. (Recommends manager
managed)
b. That there is only one operating agreement and it can only be
amended by percentage set forth in Articles. Want this in the Articles
so that a non-managing member has no apparent authority to bind
LLC and also to defeat the argument that the members/partners have
an oral agreement that is part of the operating agreement. Some
states permit oral amendments to operating agreements and some states
allow more than one operating agreement.
c. Everything else should go in the operating agreement.
3. Contributions and Distributions
a. Senda and Shepherd cases held that a contribution of property
to a
partnership/LLC by parents which resulted in an increase in value
of children’s ownership, was a transfer of the property to
the children rather than to the entity. Make sure that additional
membership interests are first given to the contributing partner/member
(i.e., credited to the contributing partner’s capital account)
and then transfer the membership interests to the children by assignment.
b. Should provide in the agreement that consent of all
members/partners is required before founding (or any other) members
can make capital contributions to entity. Generally don’t
want one owner to be able to increase his or her interest without
the consent of the other members.
c. Provide for capital calls in the agreement. May make it more
difficult to sell interests. In addition, can possibly be a way
of getting rid of a disruptive member.
d. Provide that non pro-rata distributions in kind can only be done
with consent of person receiving distribution.
e. Permit transfer of interest by member/limited partner only after
offering to the company or other members to purchase at price 3rd
party willing to buy for.
f. Agreement should allow member/limited partner to sell full interest
to 3rd party after giving right of first refusal to company and/or
other members/partners to avoid Hackle issue.
g. Dissolution and Liquidation. Watch out for 2704(b), look at state
law. Agreement cannot be more restrictive.
h. If concerned about spouses owning interests in the entity, provide
in the agreement that a transfer can be made to a trust for benefit
of spouse but not outright to spouse. This will allow gifts of interests
to a QTIP.
a. Custodial gifts. Provide in the agreement that upon attaining
age
21, custodial interests can be transferred to the child and that
such a transfer is not a prohibited transfer under the agreement.
Circular 230 Final Regulations - Requires limited scope opinions
if attorney so much as mentions tax issues relating to partnerships
etc. (i.e., attorney should provide in writing that he/she is not
giving an opinion on 2036(a) etc).
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Tuesday, 1/11/05 - Asset Protection Other Than Self-Settled Trusts
Steven J. Oshins Esq.
Reported by Gene Zuspann Esq.
This presentation will focus on Trusts - and particularly Beneficiary
Controlled Trusts (BCT)
A BCT is a trust in which the primary beneficiary is the sole trustee
or is a co-trustee and has the power to replace the other trustee.
The BCT usually includes a special power of appointment that allows
the primary beneficiary to eliminate interference by remote beneficiaries.
It waives the Prudent investor standard. If a support trust, it
must include a spendthrift provision.
Steve discussed support interests vs discretionary trusts. The
support trust allows creditors to attack the trust because of rights
of beneficary to go to court and enforce the support standard.
There are 4 exception creditors on support trusts under the Restatement
(Trusts) 2nd
He discussed several cases involving discretionary trusts and the
inability of a creditor to force the trustee to pay funds from the
trust for the claim against the beneficiary. He also mentioned a
case that allowed the IRS to obtain payment from a support trust.
Steve suggests that the trusteeship be broken up - use two trustees.
The primary bene is the investment trustee and he/she would select
the other trustee. The bene/trustee has the power to remove and
replace the other trustee.
Dynasty Trusts - if the BCT makes sense for one generation, shouldn’t
it also make sense for multiple generations. The client does not
need immense wealth, “such as the Gettys, the Rockefellers
and the Blattmachrs.” It often makes sense to use a dynasty
trust that retains the client’s assets in trust for several
generations to protect the beneficiaries and to allow the trust
to grow.
Inheritor’s trusts - a BCT dynasty trust with discretionary
powers. The client sets up the trust and the parents change their
estate plan to pour the client’s inheritance into the trust
rather than outright to the client.
Opportunity shifting - the shifting of income or wealth from the
client to others. A third party (the parent) creates the trust with
some ‘seed’
money and the client uses the seed money to create an entity to
acquire or start-up a business. This is a third party trust rather
than a self-settled trust and allows creditor protection for the
client even though the trust is later worth a substantial amount.
It can allow the client to avoid many issues in a divorce. The client
only owns a small share of the entity.
Discretionary trusts - generally creditor proof because there is
no standard of distribution. Steve only discussed the UTC for a
few moments. He refers the audience to the materials written by
the UTC committee and his materials. There are a number of concerns
being voiced about the UTC from many people in the country, and
Steve concludes that there are issues with the UTC that need to
be addressed.
In 12 states, a remainder interest in a trust is marital property.
In those states, a dynasty trust could be used to avoid the problem.
Charging orders - pg 66. Corporations do not have the advantage
of charging orders but LLCs and partnerships do. A charging order
gives the creditor only the rights of an assignee. The law varies
on this issue from state-to-state. The materials include a list
of cases from different states.
Steve discussed the Ashley Allbright case (a Co bankruptcy case)
which held that a singe member LLC does not get the benefit of a
charging order.
Disclaimers and existing creditor problems. The Drye case (pg 86)
held that a disclaimed inheritance qualified as a property right
under IRC §6321 and allowed the IRS to recover its tax lien.
Steve believes that disclaimers still work against many creditors.
Tenancy by the entirety - there is now a case (the Craft case)
that holds that for federal law purposes, the TBTE will not protect
the debtor. However, the TBTE still works in states where it is
applicable.
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Our on-site local reporters who are present in Miami this year are
Gene Zuspann Esq. of Zuspann & Zuspann in Denver, Colorado,
Shelly Merritt Esq., a solo practitioner in Boulder, Colorado, Connie
T. Eyster Esq. of Hutchinson, Black & Cook LLC in Boulder, Colorado,
Jason Havens Esq. of Havens & Miller PLLC in Dustin, Florida,
Bruce Stone of Goldman, Felcoski & Stone, PA of Coral Gables,
Florida, Herbert L. Braverman Esq. of Walter & Haverfield LLP
in Cleveland, Ohio, and Jeffry L. Weiler of Benesch, Friedlander,
Coplan & Aronoff LLP of Cleveland, Ohio. The editor again this
year will be Joseph G. Hodges Jr. Esq, a solo practitioner in Denver,
Colorado who is the Chief Moderator of the ABA-PTL List.
GENERAL INFORMATION ABOUT INSTITUTE
Inquiries/Registration
Philip E. Heckerling Institute on Estate Planning University of
Miami School of Law Center for Continuing Legal Education P.O. Box
248087 Coral Gables, FL 33124-8087
Telephone305-284-4762 / FAX305-284-6752
Web site www.law.miami.edu/heckerling
E-mail heckerling@law.miami.edu
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Telephone (305) 538-2000, FAX (305) 674-4607 ==================================================
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