1. ©Copyright Wealthcare Capital Management, a division of Financeware, Inc. 2003 All rights reserved P r o v i d i n g W E A L T H C A R E Incorporating The Family Limited Partnership in Our Advice George K. Chamberlin, JD Vice President – Financial Strategies Wealthcare Capital Management Powered by Financeware

2. ©Copyright Wealthcare Capital Management, a division of Financeware, Inc. 2003 All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 2 What Is a Family Limited Partnership? The Family Limited Partnership (FLP) is a limited liability partnership which is formed for a business or investment purpose. The FLP is created through a formal written agreement pursuant to state law. The FLP has two classes of ownership and participation - General Partner - person or entity operating the FLP - Limited Partners - holders of partnership interests Typically, both the general and limited partners are family members.

3. ©Copyright Wealthcare Capital Management, a division of Financeware, Inc. 2003 All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 3 How Is an FLP Formed? One or more of the partners transfer assets into the FLP - Nearly any kind of investment or business asset may be transferred - The FLP takes title to the assets transferred A formal partnership agreement is executed - This document specifies the names of the partners and defines who may be a partner - The agreement specifies the term of the FLP and how it continues on the death of a general partner - It outlines the powers and duties of the general partner - It specifies that partners have a limited right to transfer their FLP interests

4. ©Copyright Wealthcare Capital Management, a division of Financeware, Inc. 2003 All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 4 What are the benefits of an FLP? There are many reasons for a client to consider using an FLP, including - Ability to transfer interests to desired beneficiaries - Business continuity and succession planning - Continued client control of business operation - Protection against creditors - Reduction of estate and gift taxes on transfer

5. ©Copyright Wealthcare Capital Management, a division of Financeware, Inc. 2003 All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 5 Ability to Transfer Interests to Desired Beneficiaries First, from an estate planning viewpoint, a client may be able to transfer wealth easily by gifting or other transfers of FLP interests to meet an estate goal - Children and other family members are usually beneficiaries - The client can choose which to benefit, how much and when - There is a great deal of flexibility and control on transfers - Recipients will not be able to easily liquidate their interests - Tax benefits in the transfer may be achieved, including reduction of taxes in the estate of the client donor at death

6. ©Copyright Wealthcare Capital Management, a division of Financeware, Inc. 2003 All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 6 Business Continuity and Succession Planning The death or disability of the client, as founder of a family business, may be problematic if there is no planning in place for such event. Without the client at the helm, the business may cease operations, suffer a loss of business or encounter other difficulties. Using the FLP, with an entity as the general partner, ensures continuity even in the event the client can no longer participate. The general partner may be operated by the client and those persons (or institutions) designated by the client and under terms and conditions established by the client. - Those family members involved in the business may be selected to receive general partner interests and to continue the business while uninterested family members may receive only limited partner shares Tied with the ability to freely and flexibly transfer interests to family members, this approach ensures the succession of the business.

7. ©Copyright Wealthcare Capital Management, a division of Financeware, Inc. 2003 All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 7 Client Control of Business Operation The partnership agreement typically provides that the general partner(s) will retain control of the day to day operation of the FLP. Since the client, founder of the FLP, generally wants to remain active in the business, this level of control is attractive. It permits the client to continue to exercise those skills that built the business, even while transferring away interests to younger generations. In addition, maintaining control helps to ensure that the potential lack of experience, or existence of uncertainty or divisiveness among limited partners will not affect the continued operation of the business and its success.

8. ©Copyright Wealthcare Capital Management, a division of Financeware, Inc. 2003 All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 8 Protection Against Creditors The FLP provides some level of protection for interest holders against creditors. For example, where the client transfers limited partner interests to children and other family members, creditors of the recipients may not be able to reach those interests. Usually, creditor remedies are limited to obtaining a charging order, which may not provide much relief to the creditor. Creditors of the FLP are also limited in their ability to reach the personal assets of the partners, providing a different aspect of protection. Note that creditor protection depends, in part, on careful and thorough compliance with the operational requirements of the partnership. Both business creditors and the IRS may be able to obtain relief where the client and other partners fail to comply.

9. ©Copyright Wealthcare Capital Management, a division of Financeware, Inc. 2003 All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 9 Reduction of Estate and Gift Taxes on Transfer Each partnership interest that is transferred to family members is an asset that is removed from the client’s estate - and therefore not subject to taxation there on the death of the client. Transfers may be accomplished without gift taxes by using the maximum annual gift tax exclusion for each beneficiary. - Discounted value passes more value - Split gifts may be possible The bottom line is that significant assets may be transferred without any transfer tax - currently or in the future. This is a powerful technique for many clients.

10. ©Copyright Wealthcare Capital Management, a division of Financeware, Inc. 2003 All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 10 Modeling Issues with the FLP How may we best illustrate the impact of using the FLP on the client’s goals and objectives? There are several issues to consider in this context to ensure that we most effectively demonstrate the utility of the FLP. First, what portion of the FLP assets are included in the modeling? - Only those interests retained by the client are available to meet goals - LP and GP interests transferred to others no longer count Second, should the assets be treated as investment assets or as non-investment assets? - The client’s retained interests are generally illiquid - The relevant portion of the asset may be a cash inflow for distributions as the rest may not be reached by the client - If included as an investment asset, should the asset be discounted or stated at full market value?

11. ©Copyright Wealthcare Capital Management, a division of Financeware, Inc. 2003 All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 11 Asset Allocation in the FLP If we treat the client’s FLP interests as investment assets, we next face the question of how these interests may be allocated within the investment portfolio. An investment FLP, consisting primarily of securities, will be fairly simple to reflect as an allocation. If the primary asset of the FLP is a business or other non-security type asset, the proper allocation becomes much more difficult to determine. One approach is to reflect the FLP interests as non-investment assets for net worth evaluation. Then, we would show the anticipated distributions as a cash flow into the client’s strategies. This may be a better approach than trying to incorporate the assets as part of the investment portfolio. - Better than assuming a particular classification and return - Great flexibility in setting timing and amount of cash flows

12. ©Copyright Wealthcare Capital Management, a division of Financeware, Inc. 2003 All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 12 The Importance of Valuation Valuation of FLP interests is a central issue in their implementation, quite apart from the questions of allocation. First, when we are considering transfers of interests or value in the estate, discounts may be available as part of the tax analysis. - Lack of control discount for limited partner interests - Lack of marketability for any interests, because of partnership restrictions The discount is taken from the valuation performed – so the valuation is critical. However, when we examine the impact of the ownership of the FLP interests on other, personal goals and objectives such as retirement spending and the like, there is not likely to be any applicable discount. Note that with increased IRS scrutiny of the FLP and other similar techniques, it is important to secure an independent, professional, and supportable valuation of the FLP interests both for discounts and for tax treatment.

13. ©Copyright Wealthcare Capital Management, a division of Financeware, Inc. 2003 All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 13 Income taxation of partnerships - - The tax law looks through the partnership to partners - Distributions to the client are likely to be taxed to extent of income and realized gains – so cash flows are taxable - The other partners don’t interest us in the context of modeling since they pay their own taxes (But, it may be important for them to have ability to pay taxes on their share of income.) As we have already seen, the transfer of FLP interests is a primary goal of many partnerships - Children and other family members are usually beneficiaries - The maximum annual gift tax exclusion may be used to accomplish a gift without taxes If gift tax is due, it is necessary to model the outflow to defray this tax obligation Tax Planning Aspects of Modeling

14. ©Copyright Wealthcare Capital Management, a division of Financeware, Inc. 2003 All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 14 Summary The FLP may play a major role in the current and future financial strategies of our clients. Understanding how the FLP works and the issues encountered in modeling the FLP is important to best serve our clients. Since our goal is to assess the likelihood that a client will achieve the goals and objectives expressed to us, and not to perform an accounting level examination of their finances, remember that simplicity is the best course for our modeling. The FLP is a complex mechanism and there is much more to the FLP than the basics we have discussed. If you would like additional information regarding the FLP, we can provide you with links and resources to examine.

15. ©Copyright Wealthcare Capital Management, a division of Financeware, Inc. 2003 All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 15 Are there any questions? Thank you, George Chamberlin gchamberlin@financeware.com (804) 644-4711 ext. 138