The following thoughts and ideas outline a few issues regarding estate planning. We have chosen these issues because they are often critical to farm families with farmland as the predominate asset in the estate. With such an estate, issues such as liquidity, control of the business, and transferring of assets to the children are difficult. The following include excerpts from the book "Generations: Planning Your Legacy" by Robert A. Esperti, Renno L. Peterson and Ellen Gay Moser. Ms. Moser is an estate planning attorney in Naperville with E.G. Moser & Associates.

What role should life insurance play in my plan?
One of the key roles of life insurance is to provide liquidity. This may be especially critical for farmland owners with limited liquidity when most of the estate is in the land. A second advantage is that the life insurance proceeds could go to your beneficiaries without being included in your estate and therefore without estate taxes being charged. In order to avoid estate tax, your policy should be owned by your beneficiaries directly, or by an irrevocable trust for their benefit.

What do you mean by "owned by"?
Life insurance policies contain incidents of ownership that pertain to the rights, privileges or access to those policies. If the insured retains any of these incidents of ownership, the IRS provides that the proceeds of those policies will then be included in his or her gross estate. Therefore it is important to have all the ownership rights transferred to your desired beneficiaries.

Can my children own my policy?
Yes, maybe. However, minor children cannot own a policy. Adult children can own policies, although they must be responsible for paying premiums in a timely manner to keep the policy in force. An occurrence such as bankruptcy, divorce or lawsuit involving your children may put the policy at risk. If one of your children predeceases you, that child's interest in your policy will pass to someone else according to his/her will or revocable trust. Thus, there are some cases where you may want to consider alternatives of life insurance ownership other than direct ownership by your children.

What is an alternative?
One alternative is to establish an irrevocable life insurance trust (ILIT). This is an irrevocable trust that is created to own and be the beneficiary of life insurance policies on the trust maker's life. Properly drafted, it does not allow the insured to retain any incidents of ownership in the policies.

Why would I want to have an ILIT?
First, it will help ensure that the death proceeds of life insurance are not included in the estate of the insured or the insured's spouse. It will provide liquidity for the estate. The assets in the ILIT are protected from creditors of the donor and the beneficiaries of the trust. It can be structured to make increased transfers to grandchildren free from the generation-skipping transfer tax. With demand-right provisions, the gifts to an ILIT can qualify for the annual gift exclusion.

Are there any provisions that should be avoided in an ILIT?
Yes, some ILITs have provisions that either allow or require the trustee to pay taxes, debts, obligations, liabilities, or administrative expenses of the insured or insured's estate. Such a provision is a fatal flaw and should be avoided. A properly drawn ILIT will allow the trustee to lend money to, or buy assets from, your estate. In this way, cash is moved to your estate to pay the various obligations without causing the life insurance proceeds to be included in your estate.

What about transferring some of my assets to my children and grandchildren now?
I understand that I can make $10,000 gifts to them annually which I prefer. I can do that through the family business. However, I do not want to lose control of the business while I am alive. How can I do both? One alternative for this scenario may be a family limited partnership.

This answers the question of how can I keep control of the business?
Yes. Quite often you as parent and/or grandparent and current sole owner of the business can become the general partner of the FLP. You maintain complete control of the business as the general partner. Then, you may transfer a majority of the business to your children, grandchildren, or trusts for their benefit in the form of limited partnership interests. The limited partners have no ability to vote or manage the business, but do have equity interest in the business.

Can I make minor children limited partners in an FLP?
Yes, but it might be a good idea to hold their partnership interests in some kind of trust. It is difficult for minors to own property directly.

How can an FLP separate income and equity interest in the partnership assets from the managerial control over those assets?
Limited partnership statutes in all fifty states specify that this must be the case. These statutes not only allow parents and grandparents to give away massive amounts of equity but also allow them to continue to manage that equity.

How can I use an FLP for giving property to my children?
Typically, you the parent, will be the general partner and also the initial limited partner. You will then make gifts of limited partnership interests to your children, grandchildren or trusts for their interests. In addition to the control issues, there are several advantages to making gifts of limited partnership interests: First, the general partner can receive partnership income as payment for management services and as a "special allocation" of partnership income. Second, the limited partnership interests are valued at a discount, usually at least 25%, from their pro rata share of the assets inside the partnership. Third, the FLP offers asset protection for the individual partners.

How does an FLP help reduce the value of an estate?
The FLP helps in reducing the value of the parents' estates by qualifying for various "valuation discounts." The federal estate and gift tax is a tax on the transfer of property during the owner's life or at his or her death. The tax is based on the fair market value of the property transferred. Fair market value is the value at which property would change hands between a willing buyer and a willing seller, both having full knowledge of all relevant facts and neither being under any compulsion to buy or to sell. In determining the fair market value, a willing buyer will demand certain discounts in the value of property that cannot be readily sold or that the buyer cannot control.

In other words, the creation of the FLP transfers assets that are fully controlled by the parents to a small general partnership interest and a large limited partnership interest. Thereafter, the parents no longer own the assets outright; they own their general partnership interest, which gives them total control, and a limited partnership interest, which lacks marketability and control. In establishing fair market value of the limited partnership interest, a willing buyer would demand a discount for lack of marketability and control. Thus, even before any transfer of limited partnership interest to the children, the valuation of the assets is discounted and reduced. These discounts will usually range from 25 to 60 percent.

When we give limited partnership interests to our children and grandchildren, what is their cost basis in the interests?
The interests given by parents retain the parents' income tax basis. Unlike assets the parents leave at death, the FLP interests do not receive a stepped-up basis to date-of-death value. When the limited partners-children and grandchildren-sell their interests at a later date, there will be capital gain tax due if the sales price exceeds their parents' and grandparents' basis in the interests.

You mentioned using a limited liability company (LLC). What exactly is an LLC?
A limited liability company is a hybrid business entity that possesses certain attributes associated with corporations and certain attributes associated with partnerships.

Instead of having partners or shareholder, the LLC has members. Members enjoy limited liability status regardless of whether or not they participate in the day-to-day affairs of the business. This means that LLC members can participate in the management and control of the business without risking their personal assets to liability as a result of the acts of others.

An LLC is generally treated as a partnership for purposes of federal and state income taxation. Because partnerships are not subject to corporate income tax, an LLC offers the limited liability of a corporation without the additional level of income taxation associated with regular corporations.

What can an LLC do for me?
An LLC is a noncorporate business entity which provides its owners with limited liability, flow-through tax treatment, and operational flexibility. It reduces the paperwork associated with incorporation, and it simplifies tax planning.

Are there any provisions that should be avoided in an ILIT?
Yes, some ILITs have provisions that either allow or require the trustee to pay taxes, debts, obligations, liabilities, or administrative expenses of the insured or insured's estate. Such a provision is a fatal flaw and should be avoided. A properly drawn ILIT will allow the trustee to lend money to, or buy assets from, your estate. In this way, cash is moved to your estate to pay the various obligations without causing the life insurance proceeds to be included in your estate.

What about transferring some of my assets to my children and grandchildren now?
I understand that I can make $10,000 gifts to them annually which I prefer. I can do that through the family business. However, I do not want to lose control of the business while I am alive. How can I do both? One alternative for this scenario may be a family limited partnership.

What is a family limited partnership?
A family limited partnership (FLP) is a limited partnership in which all the partners are family members or entities created by or owned by family members. This is a common form of business entity that consists of at least one general partner and one limited partner. The general partner, who can own as little as 1 to 2 percent of the partnership interests, has the entire right to manage the business and can be held personally liable for partnership debts. A limited partner has no right to participate in managing the partnership business and has limited liability for partnership debts.

This answers the question of how can I keep control of the business?
Yes. Quite often you as parent and/or grandparent and current sole owner of the business can become the general partner of the FLP. You maintain complete control of the business as the general partner. Then, you may transfer a majority of the business to your children, grandchildren, or trusts for their benefit in the form of limited partnership interests. The limited partners have no ability to vote or manage the business, but do have equity interest in the business.

Can I make minor children limited partners in an FLP?
Yes, but it might be a good idea to hold their partnership interests in some kind of trust. It is difficult for minors to own property directly.

How can an FLP separate income and equity interest in the partnership assets from the managerial control over those assets?
Limited partnership statutes in all fifty states specify that this must be the case. These statutes not only allow parents and grandparents to give away massive amounts of equity but also allow them to continue to manage that equity.