Wealth Planning News
Vol. II, No. 5
Family Limited Partnerships
A family limited partnership [FLP] is an entity owned mostly by family members. The owners are parents (or a single parent), and one or more children (or even better, gifting trusts created for children or their descendants). State law sanctions the entity, so it is a legal person under the law, with federal tax law implications.
You frequently read and hear conflicting information about FLPs. One article says they are great. Another says they are hated by the IRS and may not work. What are you to believe? Both claims are true. The IRS hates FLPs because they work if they are properly designed, documented, and implemented. The creation of an FLP is work for experts, not form sellers. You can really get hurt thinking of the work as punching paper out of a computer.
Each FLP must be individually designed, properly documented, and properly implemented. An FLP is a living company. Each design feature from choice of the general partner or general partner entity on down the list, is critical. Control issues, extent of asset protection, income tax traps, and management conflicts are all involved. Creating an FLP that would qualify for significant valuation discounts is at least ten times as difficult as preparing the normal limited partnership.
Why Use an FLP?
Central Management of Investments
Use the FLP for central management of investment assets. Train descendants to manage assets. Train them to invest, and let them watch you. And you can keep the ultimate control of all investment and income distribution decisions.
The FLP provides asset protection under the laws of most states. If made in such a state, FLP assets are normally protected from creditor claims against any partner, wherever the claim is asserted. For business owners, professionals and people with wealth, the asset protection features of the FLP are a substantial business purpose for creation of the entity.
Laws in many states effectively, and in some states expressly, preclude a judgment creditor from taking your partnership ownership interest to satisfy the judgment. And of course the company owns the assets, not you. So a judgment creditor can only obtain a “charging order” to collect your share of any income distributed by the partnership.
In This Issue
Why Use An FLP?
If the general partner decides to not distribute partnership income, the judgment creditor has no income to collect from you. While no domestic entity can provide assured asset protection, use of an FLP can be a strong deterrent to suits and can promote reasonable settlement of claims against owners of interests in a family limited partnership.
Retained Control Over Gifts
Parents who control the general partner can control investments and income distributions. Control exists because limited partnership units have no vote in the FLP. People who create FLPs often want to make gifts of limited partnership interests to descendants. For several reasons, we strongly recommend that gifts of ownership units be made to trusts for descendants instead of being given outright.
Gift and Estate Tax Savings
Since discounts apply to fractional interests in a closely held business, the amount that parents can give each year can be dramatically increased. If a discount of 50% would apply to a particular FLP minority ownership interest, a parent could effectively gift double the normal annual exclusion gift amount from the taxed estate each year for each gift recipient.
Valuation discounts also reduce the taxed value of an estate. If the applicable valuation discounts were fifty percent, a parent owning half of a limited partnership parents passing such an entity to future generations could double the value of any estate or inheritance tax exemptions available in future.
For more information on this topic call us to arrange for a free consultation.