A Family Limited Partnership (FLP) is a limited partnership that families use to manage family enterprises and other family investments. The FLP has two classes of partners—general and limited. The general partners retain managerial and financial control over the partnership. Typically, once the senior family member(s) transfer the family assets into the FLP, they keep the general partnership interests, which are typically a small percentage of the partnership, and transfer the limited partnership interests to the younger family members through gifts.
The gift of limited partnership shares may be subject to a valuation discount due to lack of marketability and the fact that these interests have no control or management rights.
The use of a FLP also protects assets from lawsuits. Most state limited partnership statutes prevent creditors of limited partners from attaching partnership assets. While the creditors may get a charging order against the debtor’s partnership interest, it is very difficult to collect the debt. In fact, the creditor may incur income tax liability as a result of the charging order while receiving no revenue.
How It Works:
Download Using Family Limited Partnerships
- By forming a Family Limited Partnership, the parents can transfer asset value and shift asset growth from themselves to a younger generation. This then reduces the size of the parents’ estates
- Partnership income can be divided among various family members perhaps creating some income tax benefits by shifting income to lower tax bracket individuals
- Creditors of limited partners can only get a “charging order” against a partner’s share of distributed income. The creditor cannot attach a partner’s share of partnership assets nor force a distribution of income
- Senior family members continue to retain full managerial and financial control over the assets
- Where liquidity is needed for estate tax purposes, the FLP can use income from assets to purchase a policy on the parent’s lives and be owner and beneficiary. At death, the insurance proceeds are received income tax free by the FLP and divided according to ownership interests. Typically, the general partnership shares of the insured will only represent 1% of the FLP and therefore only 1% of the death benefit will be included in the deceased's estate. The rest of the death benefit passes to the FLP outside of the estate and is estate and income tax free. These death benefit proceeds can be used to buy assets from the deceased’s estate to provide the needed liquidity
- The actual savings realized through this strategy depends upon the actual value of the assets transferred into the FLP, the size of the gifting program adopted and the amount of the discount involved in valuing the gifts
- The IRS has consistently challenged the available tax benefits, but recent cases support the viability of limited partnerships and the valuation discounts they may provide. Future Congressional action may eliminate or restrict the use of FLPs as an estate and gift tax savings vehicle so it is important to form the FLP soon while the benefits are still available
- When an FLP has been treated like the owner’s personal pocketbook, without regard for the legal formalities of the partnership entity, the IRS has often challenged the tax benefits and won its case. This is also the case when an FLP has been established near the time of death for the sole purpose of reducing estate taxes
- It is important that legal advice be obtained when establishing an FLP. An FLP is not appropriate for every situation. In addition, the documentation for the partnership must be carefully designed to avoid problems with both federal and state laws