What are the estate planning benefits of a trust versus a family limited partnership?

For families, couples or individuals with large or complex estates, estate planning typically means more than just writing a will. Families frequently turn to advanced estate planning strategies like trusts or family limited partnerships (FLPs) to reduce tax liability, protect assets and help ensure that loved ones are provided for.

Do you need a trust or an FLP — and if so, which one makes more sense for you? Keep reading to learn more about both.

Who should consider advanced estate planning strategies like a trust or family limited partnership?

Irrevocable trusts and FLPs are expensive to set up and administer, so consider that if you have a smaller estate, you may be fine with just a will or revocable trust. However, here are some factors to help you decide if a more complex trust or FLP could be useful:

• Both irrevocable trusts and FLPs can help you reduce or avoid estate tax or gift transfer tax exposure for significant assets you plan to distribute to heirs or beneficiaries.
• Family limited partnerships are complex and may be expensive and are generally only useful to wealthy families with major assets they wish to gradually disburse over time.
• Trusts may be less costly and help you avoid probate, which gives them broader utility, especially if you want to maintain privacy during an estate transfer.

What are the benefits of a trust?

In some respects, a trust is similar to a will. It allows you to establish plans for your estate, name beneficiaries and disburse assets in due time.

However, unlike a will, a trust can help limit your exposure to estate taxes. Trusts allow you to transfer assets into a structure that exists outside of your estate, which can be useful if you’re nearing or have already exceeded your lifetime gift exemption.

Legally, a trust also allows you to avoid probate court in most circumstances. Assets assigned to a trust are transferred to beneficiaries without a court ever getting involved, except during a lawsuit between beneficiaries or trustees.

Trusts can be either revocable or irrevocable. A revocable trust can be changed after it has been established, while an irrevocable trust, once created and signed, is locked in.

However, in either case, the trustee, who will not be the person who funds the trust in the case of an irrevocable trust (a grantor may also be a trustee for a revocable trust), has authority over the trust once it is established.

3 types of trusts to consider: SLAT, IDGT and GRAT

There are many different kinds of trusts. However, spousal lifetime access trusts (SLATs), intentionally defective grantor trusts (IDGTs) and grantor retained annuity trusts (GRATs) are three common variations to consider if you’re looking to strengthen your estate planning strategy or tax position.

Spousal lifetime access trust

SLATs allow one spouse to fund a trust for the other spouse and that spouse’s descendants. The beneficiary spouse is then free to access those assets if needed.

This can be a way for you to move growing assets out of your estate without giving up the ability to draw on those assets should your circumstances change. A SLAT also allows your assets to pass tax-free to beneficiaries or descendants.

However, should a beneficiary spouse die before the spouse who funded the trust, the assets in the trust then pass to the beneficiary’s descendants, not back to the other spouse. This same scenario would also happen during a divorce.

Intentionally defective grantor trust

An IDGT is another common vehicle to allow you to move assets to a trust to reduce transfer and estate tax liability. Here, the grantor retains certain powers in that trust that cause them to continue paying income taxes on assets held by the trust. When there is a taxable estate, this can be beneficial as it allows the grantor to provide a larger benefit to the beneficiary by paying the income taxes.

Because assets are transferred to the trust, the assets inside of an IDGT are typically not subject to estate taxes when the grantor dies.  This means that any future appreciation on those assets is outside of the estate as well.

This type of trust can be especially useful for individuals who own a business they later plan to sell.

Grantor retained annuity trust

A GRAT essentially combines a trust with an annuity. For example, if you put $1 million into a GRAT, it will pay you back that $1 million plus a required return as an annuity spread out over a certain number of years.

From a tax perspective, this is valuable because the initial $1 million you put into the GRAT is then invested by the trust. If that investment earns a $500,000 return, then a significant portion of the earnings transfers directly to your beneficiaries without being subject to the estate tax.

A GRAT can be a great option for someone who has already used up most of the lifetime gift exemption and wants to transfer future appreciation of an asset or portfolio to heirs tax-free. However, given that GRAT annuity periods typically only last for a few years and can involve high setup costs, this structure is best used only in specific scenarios.

What is a family limited partnership?

An FLP is a more complex estate planning strategy that may be useful for certain families or individuals. It is a partnership structure headed by a general partner or manager that allows you to move assets outside your estate and slowly pass them on to family members.

Key elements of a family limited partnership include:

• Reduce estate tax exposure: By moving assets outside of your estate, an FLP helps you limit your estate tax liability.
• Active management: Unlike a trust, which is overseen by a trustee rather than the grantor, an FLP allows you as the establishing partner to actively manage or retain some authority over those assets until you have transferred your interest in the partnership to your heirs.
• Income stream: As the general partner to an FLP, you can create a payment stream for yourself from the partnership’s income.
• Transfer over time: An FLP allows you more flexibility than a trust in timing when you transfer assets to family members, because you can pass on the controlling interest in the partnership gradually.
• Generational impact: While some families choose to dissolve an FLP after a limited period of time, FLPs often last for generations, creating an ongoing legacy.
• Flexible ownership structure: FLPs can be set up within an LLC or even combined with a trust for additional optionality.

FLPs can be especially beneficial for families with businesses that they wish to pass on to their children. You can move the business into an FLP, while retaining de facto ownership of the business as the general partner in the FLP, and then gradually cede that ownership as your children come of age or take on more responsibilities within the business.

What are the key differences between a trust and an FLP?

Valuation is an essential factor for maximizing the tax benefits from both trusts and FLPs

When you transfer an asset like a business into either a trust or an FLP, that asset needs to be valuated for tax purposes. Achieving a lower valuation during this process will help you transfer more wealth without accruing tax liability.

Work with a tax and valuation advisor here. An experienced advisor can limit your valuation and also help you benefit from cost-saving strategies like doing a valuation near the end of the year so you can make two annual gifts based on the same valuation.

How Wipfli can help

We help families and individuals pursue advanced estate planning strategies like trusts, family limited partnerships and lowered valuations on transferred assets. Let’s talk about your goals and how we can help you achieve them. Start a conversation or watch this free webinar to learn more.

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