But good investment results and counseling are crucial to its success.
Investment-driven estate planning comes into play when fulfilling a client's dispositive wishes depend upon investment results, so the two become inextricably woven together. Let's pursue that theme with a smart idea for charitable giving that simply does not work without good investment counseling and good investment results. But the concept is a real winner if the investment advisor understands what the estate planner is doing and vice versa.
The idea is the Charitable Family Limited Partnership (CFLP ), which is a charitable giving vehicle that provides a substantial gift to charity, produces income tax savings for the donor, transfers significant wealth to the donor's descendants and allows a means for the donor's family to retain control over the transferred assets.
The basic structure of the CFLP is that senior members, usually parents, contribute appreciated assets to a limited partnership in exchange for general and limited partnership interests. The general partners, usually the parents, manage the affairs of the partnership and typically receive a reasonable management fee for their services. (If this fee is unreasonable, great damage is done to the integrity of this planning option.) The limited partners do not participate in the CFLP's management. As general partners, the parents retain control over the property transferred to the partnership. In addition, they control the entity or person selected as investment advisor, so they determine the partnership's investments and when and if any distributions will be made out of the partnership.
Once the partnership is formed, the parents transfer a small portion of their limited partnership interests to their children. They contribute their remaining limited partnership interests to charity, claiming a charitable income tax deduction for their full fair market value at their appropriate valuation.
The partnership then sells the appreciated property. Because the partnership income is allocated to partners in accordance with their pro rata shares and the charity owns nearly all of the limited partnership interests, nearly all of the gain is allocated to the charity, which is tax-exempt. Therefore, most of the gain escapes taxation. This eliminates the need for the partnership to make tax distributions (assuming the other partners are otherwise able to pay their relatively small tax), and leaves more property in the partnership from which the children will benefit.
The proceeds of this sale are reinvested. Eventually the partnership liquidates, and the charity receives its share of the reinvested assets. The partnership also may make pro rata distributions to the partners that could provide an immediate benefit to charity and to the children, as well as to the general partners, but probably to a more limited extent.
An alternative to giving the charity a steady share of the reinvested assets is giving it a "put" right, which requires the partnership to buy the charity's interest after a period of time. The price that the charity will receive may be discounted to reflect the lack of marketability of the limited partnership interest and the fact that the charity has no management control. A discount also may be appropriate because the charity will be liquidating its interest before the end of the partnership's term. The remaining assets then belong to the other partners, usually the donor's children and the donors themselves, who receive a lesser portion. Because the amount the partnership pays to redeem the charity's limited partnership interest is discounted, the amount of the discount is effectively transferred to the remaining partners. Thus, significant wealth is transferred to the children, free of gift and estate taxes, making this technique superior to some of the more familiar wealth-transfer devices, such as charitable lead annuity trusts and charitable remainder trusts.
Before the gift of the partnership interest to the charity, it is vital that there is no agreement for the partnership to buy back that interest. Such an arrangement could lead to a finding that the gift was not complete and cause the collapse of one of the pillars upon which this technique stands.
Remember that if the charity does not exercise its put right and instead retains its limited partnership interest until the dissolution of the partnership, the charity will realize the full, nondiscounted value of its interest. In such cases, the CFLP's estate planning benefits-the transfer of the amount of the discount reflected in the purchase price for the charity's limited partnership interests-is forever lost.
Since a picture is worth a thousand words, an example (somewhat complicated but worth the effort) is worth a thousand words. For example, parents own appreciated securities and would like to sell them to diversity their investments, but have hesitated to do so because of the substantial capital gain they would incur, even at a 20% rate. The parents would like to transfer most of their wealth to their son, but also are interested in providing a benefit to charity. It is vital to understand that there must be a charitable element to the parents' objective or this technique is not the right one. It does mean that this concept might transfer both more to charity and more to their son than many other ways of proceeding, but it is a sharing of benefits between the charity and the family.