Category: Estate Planning

This Preventive Law Alert was written by: John Goodson, Colleen Manley and Christine Goodson Forakis.

Summary

We strongly recommend that all families with family limited investment partnerships utilize the Capstone Pillbox (CP) as the owner of the General Partnership interest, usually a 1% General Partnership interest with 99% owned by various family trusts.

To create the Capstone Pillbox, we establish the standard Limited Liability Company documentation and file the requisite IRS form to declare it to be taxed as a "C" corporation. We arrange for a check in the amount of $100 to be placed on behalf of the client in the firm's Entity Confirmation Trust Account to breathe life into the LLC. The check confirms the effective date of the LLC and confirms the ownership of the LLC at the time of inception, which is usually the family's Revocable Trust initially owning 100% of the Capstone Pillbox LLC. In the CP creation documents we reflect that initially there will be 10% managing interests and 90% non-managing interest.

After creating the LLC with the $100 check, the now living LLC receives the transfer of another set of assets; the furniture and equipment in the home office, which will be the operations room for the business of the Capstone Pillbox LLC. At this point it becomes necessary to have an informal appraisal of the 1% General Partnership value, and the value of the furniture and equipment transferred into the Capstone Pillbox LLC to arrive at the total value of the Limited Liability Company before gifting Limited Liability Company percentages to the children or grandchildren's Irrevocable Trusts.

We recommend the optimum gifting percentages to be 5% of the managing interest, and all 90% of the non-managing interest as a completed gift to the children or grandchildren's Revocable Trusts. This leaves 5% of the managing interest owned by the Revocable Trusts so that the Irrevocable and Revocable Trust will have 50-50 control of the CP.

At this stage there is an organizational meeting, similar to a normal corporation, and the family will elect directors, a president/CEO, a vice president/COO, secretary and Chief Administrative Officer, treasurer/CFO, and possibly a Chief Marketing Officer and Chief Property Management Officer.

The managing members will execute a Certificate of Power and Authority which authorizes the patriarch or matriarch (usually) to be the President and Vice-President, respectively – at least in the beginning to insure the patriarch and matriarch remain in control of managing the CP and limited partnership. This equal management arrangement prevents any one of the parties from changing the control arrangement without 100% concurrence.

In life, you never want to set up something unless a major evil is prevented or a major benefit is created. Therefore, we recognize the following benefits from a CP arrangement:

1. Entity is separate from other operating businesses. With 50-50 deadlock control, the CP may be operated as a separate tax paying entity even though the client may be operating another business enterprise with employees. The deadlock control allows the fringe benefits implemented for the family CP and do not have to be integrated with the fringe benefits of any other corporations owned by the family where they have multiple employees and lesser benefits.
2. Directors' fees to low bracket tax payers. Parents and children may be brought in as directors to receive director's fees in low tax brackets.
3. Sur tax exemption uses low tax bracket. Because the CP is taxed as a "C" corporation, the first $50,000 of income will be taxed in the 15% bracket, which is most times much less than the tax rates of clients who are setting up this arrangement.
4. Advantageous management fee. As soon as the CP is in operation it will contract with the family's investment limited partnership to become its manager with a management agreement. This management agreement, along with the terms of the limited partnership, which give an off the top bonus to the general partner will provide funding for the CP to be used for the tax benefits discussed in #5 below. A standard management fee is 2% of the fair market value of the assets of the limited partnership, 20% of the net income of the limited partnership, or a fixed fee determined by the CPAs who are advising the family with concurrence from the advisory attorney.
5. Enjoy tax deductible fringe benefits. The CP is qualified for significant fringe benefits which benefit the family members involved – medical insurance, umbrella liability insurance, long-term care insurance, disability insurance, retirement plans and other tax deductible benefits that are only available to "C" corporations.
6. Allows additional retirement benefits. The CP allows creation of additional retirement plans that supplement retirement plans of the other businesses operated by the family.
7. Deduct meeting expenses. The shareholders, directors, and officers of the CP may schedule meetings and have the CP cover the costs of the meetings – travel, per diem, lodging and other expenses. The family may even schedule a directors meeting and business retreat in Hawaii, or any other location, and deduct most of the expenses of the venture.
8. Favored tax treatment of limited partnership income. Without having the General Partnership interest in the CP, the individual client or Revocable Trust as the general partner may have the income being taxed as income from the limited partnership, all being taxes as earned income subject to withholding, FICA and Medicare taxes. Even if an individual is the 1% General Partnership owner and also the owner of a limited partnership interest, it is possible the IRS may treat all of the income to the client as earned income in the highest bracket with the greatest withholdings and employee taxes. With a CP the income from the limited partnership interests of the client will be treated as passive income and not subject to any active income detriments.
9. Employment of family members. By involving the elderly parents, children and grandchildren as directors and employees of the CP they are entitled to receive income in a lower tax bracket and the right to receive tax deductible fringe benefits.
10. Opportunity to educate family members. Involving children and grandchildren will create a vehicle and learning environment for teaching the next generations how to operate family investments.
11. A vehicle to start new businesses and deduct the initial expenses. A CP may be used for the embryonic work on new business opportunities where the new business may be nurtured under a business organization until it reaches a point to be spun off into a separate LLC.
12. Manage additional entities. The CP may be engaged to manage assets of multiple limited partnerships or LLCs so as to increase the income of the CP.

It is our opinion that whenever you have a limited partnership it is highly beneficial to have a CP as the general partner. In larger partnership situations, we may have the CP as merely the manager of the limited partnership and have the General Partnership itself owned by a separate CP, or what we call a double CP. Whether the complexity warrants a double CP is up to the advising attorney.

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