Family Limited Partnerships & Legal Implications for Estate Planning
Families with significant assets are wise to consider Family Limited Partnerships (FLPs). An FLP is a useful structure for wealth preservation by protecting assets, planning an estate, and minimizing taxes. When properly executed, an FLP can save families significant amounts of money in gift and estate taxes. FLPs both protect assets from creditors and provide flexibility, since they can be revised and altered as circumstances change.
While an FLP can be a great way to take advantage of estate tax protections, an FLP must have a purpose beyond merely reducing estate tax liability to be legitimate in the eyes of the IRS. You should consult an attorney if you want to form an FLP.
An FLP is a partnership among family members that allows joint ownership of family-owned assets. Family members act either as general partners or limited partners. General partners are responsible for controlling administrative and investment decisions and have unlimited liability. The general partner will be compensated according to the partnership agreement, either through a share of the profits or an annual fixed salary. The general partner is responsible for daily management of the FLP, such as hiring decisions, deposits, and withdrawals. Limited partners have no management responsibilities and are only partially liable. Limited partners vote on the partnership agreement and collect interest and profits. Generally, limited partners cannot lose more than they have invested in the partnership.
The structure of an FLP allows a partner to transfer a portion of his or her ownership of the assets held within the partnership to other family members who are also partners. Generally, parents and grandparents donate assets in exchange for general partner and limited partner interests. They can donate all or a share of the limited partner interest to their children and grandchildren, either directly or through a trust. Using FLPs to make lifetime gifts and transfers at death lays the groundwork to obtain a discount on the value of the transfers. The partnership is not taxable, but owners of a partnership report the partner’s income and deductions on their personal tax returns relative to their interest.
There are many advantages to an FLP, including reducing the taxable estate of older family members. The older family members can transfer property to their children in order to remove it from their estates and shield it from federal estate taxes, while maintaining control over decision-making and investment distributions. FLPs are also entitled to the gift tax exclusion, a significant mechanism for minimizing income, gift, and estate taxes. Legally, the worth of FLP shares can be reduced when transferred to family members. And, due to its flexibility, family members who own shares can alter the partnership as conditions change.
An FLP also can protect assets from creditor claims and former spouses. Creditors cannot force distributions, vote, or own a limited partner’s interest without the approval of the general partners. After a divorce, a limited partner is no longer a family member, and the partnership agreement can mandate transfer back to the family for fair market value, keeping the property within the family.
An FLP is useful for families with significant real estate assets. Using an FLP to make gifts of real estate in the state where the donor does not live can eliminate subsidiary probates. A partnership interest is treated as personal property and subject to probate online in the state of the decedent’s domicile, even if the partnership owns real estate.
Combining family investments together in an FLP reduces a family’s investment fees considerably. Instead of individual brokerage accounts or trusts for each child, the partnership can hold one account, and the children can own interests in the account.