Family Limited Partnerships

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Family Limited Partnerships

 

 

The Family Limited Partnership has many of the same characteristics as regular partnerships. Partnerships are easy to establish; two or more people can simply decide that they want to form a partnership. However, partnerships have unlimited liability. Each general partner is 100% liable for the partnership. This means that any general partner could be fully liable for all partnership debts, regardless of the percentage owned.

 

The partnership does not pay taxes. The individual partners pay taxes on the income the partnership receives. The amount of income each partner receives depends on the percentage of the partnership each owns. The partnership must file one information return saying how much the partnership made. The partners then include their share of income on their individual returns and pay taxes on the partnership's income. Partners must pay taxes on this income even if they do not receive any distributions.

 

Your Family

 

A Family Limited Partnership is an excellent way to transfer your business and your assets to your children. You can pass the assets (including the business) to your children while still maintaining control of everything. Control of the assets shifts either at your discretion or when the FLP terminates.

 

An FLP can involve the entire family in business decisions. Although family members have little control as limited partners, they are able to vote in some situations. You'll be able to see how different family members work together. An FLP can promote family unity.

  

 

What Are Family Limited Partnerships?

 

 

 

A family limited partnership (FLP) is a business created by an agreement between an individual and certain members of the individual's family. It is typically used when an owner of real estate, a business or a farm wants to centralize and consolidate management and to reduce estate transfer costs by shifting future increases in value to younger generations. The FLP is a business and financial planning device that can combine business operational planning, personal tax planning, transfer of family wealth, and business succession planning, all under one flexible arrangement.

 

 

The FLP utilizes the limited partnership entity, which you may remember from its heyday in the 1970s as the vehicle of choice in many syndicated tax shelters, until tax law restrictions curbed many tax shelter activities. Instead of syndicating an oil and gas drilling operation or a real estate development project, the limited partnership has recently been adapted for use in the family setting.

 

 

FLP General Partners

 

 

A general partner has unlimited personal liability for the debts of the partnership. Unlike a corporate shareholder, the general partner's personal (non-business) assets are not insulated from the reach of the partnership's creditors if things go badly in the business. In fact, the general partner is in yet greater jeopardy; he or she is personally liable for partnership-related contractual commitments made by other partners and for their negligent or other wrongful business acts, as well as for his own.

 

 

Thus, the general partner is of necessity exposed to considerable risk, much of which is beyond his or her control (except to the extent co-partners are selected wisely). To protect against such risk, the general partner may be a corporation in which insulation from unlimited liability is possible for the owners.

 

 

FLP Limited Partners

 

 

The situation is different for the limited partner. Much like the corporate shareholder, the limited partner's liability extends only to the amount of his or her investment in the partnership. Thus, the limited partner's personal assets are shielded from partnership creditors, but his or her capital investment in the business is at risk.

 

 

What the limited partner must sacrifice to achieve this protection from personal liability is any voice in the operational affairs of the partnership, which is strictly the prerogative of the general partner(s). Nevertheless, the limited partner has the right to participate in the profits of the partnership as a proper reward for putting capital at risk.

 

 

 

What Makes the FLP Attractive?

 

 

 

That brings us to the family limited partnership (FLP). This is just a special case of the limited partnership in which two or more members of a family, often members of different generations, fulfill the roles of general and limited partner(s).

 

 

Normally, older members manage the FLP as general partners. The standard rules for limited partnerships apply in the case of an FLP.

 

 

An FLP is an effective estate and financial planning tool to accomplish some or all of the following:

 

 

           centralize and streamline management of assets;

           protect assets from a limited partner's creditors;

           help to preserve and pass family wealth to members of younger generations;

           minimize gift and estate taxes as wealth shifts between generations;

           provide for successor ownership of the family business;

           save income taxes by splitting the income from the business among family members in lower tax brackets;  and

           provide great planning flexibility, allowing ample room for a change of heart or a change in circumstances.

 

 

 

 

Protection of Assets

 

 

Much like a trust, the FLP facilitates the transfer and control of family assets through a succession of generations. Family assets are protected against unnecessary estate taxes, the personal creditors of family members who are limited partners, and judgment creditors arising out of litigation, which is especially important in high-risk businesses.

 

 

Preserving and Passing Family Wealth

 

 

FLPs can be an effective vehicle for the management, accumulation, preservation and transfer of family wealth. An interest in the FLP, whether as a general partner or as a limited partner, is a "property right" and has value as do other types of property.

 

 

Part of the FLP usefulness is that it can provide for the succession of family ownership and control between generations as it shelters assets from taxes and creditors.

 

 

Saving Gift and Estate Taxes

 

 

The FLP can facilitate the transfer of wealth by reducing gift and estate taxes. The tax-savings provisions of the federal transfer tax laws—the applicable exclusion amount and the gift tax annual exclusion, work well in the FLP planning environment.

 

 

The IRS has ruled that a gift of FLP shares was a gift of a present interest for Section 2503 (gift tax annual exclusion) purposes [TAM 199944003].

 

 

If partnership interests are transferred to younger family members when the business itself is young, the interests so transferred may not yet have risen to the high values they will later on for gift or estate tax purposes.

 

 

 

In addition, there may be special valuation discounts the courts have recognized for transfers of FLP interests: the so-called "lack of marketability discount," and the "minority interest discount."  For now, it is sufficient to observe that these discounts, when available, enable wealth to pass to younger generations via an FLP at a significantly lower tax cost than might otherwise be possible.

 

 

 

Successor Ownership of Family Business

 

 

 

The federal transfer taxes are only part of the problem. A family business can create family discord over its disposition. The family members who are active in the business expect to be rewarded and given the opportunity to participate in its ownership. Those who are not active in the business expect to be treated fairly when the estate is distributed, which may be difficult if the bulk of the estate consists of the business.

 

 

Sometimes, non-family members play key roles in the business and also must be taken into account.

 

 

Many of these practical aspects of transferring a family business can be resolved through the use of the FLP.

 

 

 

Splitting Family Income

 

 

 

FLPs permit the net earnings of a family business to be split among several members of the family, thereby reducing the annual income tax burden. Rather than all the net earnings being taxed at the top federal tax bracket of the highest-earning family member, some of the income may be taxed in the lower brackets of other family members.