20 June 2018

This ain't no FLiPping trust

It is common knowledge that trusts are ideal wealth planning structures for families as they allow the settlor to assign the economic value of assets to family members while reserving control to trustees or retaining it themselves. The assets are therefore protected for, and in many case from, family members presently and for future generations.

Persons who are domiciled or deemed domiciled in the UK and who settle trusts for the benefit of non-charitable objects such as their families are subject to punitive upfront charges to UK inheritance tax ('IHT') – at rates of 20% initially and then of up to 6% every 10 years, and on the extraction of value from the trust.

An alternative solution that accomplishes a family's goal of separating economic value from control can be achieved by placing assets in a Family Limited Partnership ('FLP'). An FLP is not a settlement for IHT purposes and is not subject to the upfront and ongoing charges. Transferring value to family members through an FLP is a potentially exempt transfer ('PET') and subject to UK capital gains tax (to the extent the assets being transferred have built-in gain) but not to IHT so long as the transferor survives the transfer by seven years. For US federal estate and gift tax purposes, the transfer is a gift and will diminish the transferor's lifetime estate and gift tax exemption, which currently stands at roughly $11.18m (after a generous annual exclusion of $15,000 to each recipient).

While the form of an FLP is quite different to that of a trust, the parallels are remarkable: the 'trustees' assume the role of the 'general partner' of the FLP and control all substantive decisions, and the trust 'beneficiaries' assume the role of 'limited partners' and own the economic value of the partnership's assets.

Instead of the beneficiaries receiving 'trust distributions', the limited partners receive 'partnership distributions', which are made at the sole discretion of the 'general partner'.

As an FLP is a pass-through entity which is largely tax transparent for income and capital gains tax in most countries, it is possible to form the FLP in a range of jurisdictions to account for the family's geographic preferences for their investment advisor and their tolerance for political risk.

An FLP is a good wealth transfer structure in a host of scenarios, including:

  • Deemed domiciled US citizens transferring assets to their US citizen children.
  • UK domiciled grandparents transferring assets to their US citizen or UK resident grandchildren.
  • UK deemed domiciled matriarch or patriarch transferring assets to the family-at-large where each family member has a different tax residence.
  • Families who want to invest collectively to preserve greater purchasing power.

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