Understanding
Family Limited Partnerships
By Timothy M. McNamara
A family limited partnership (FLP) can be an
effective means of protecting assets and transferring wealth between generations while
minimizing taxable consequences. FLPs have also played an important role in family estate
planning, because of the many nontax advantages they offer. Let’s take a closer look
at the ins and outs of FLPs.
How It Works
Formed under state law, an FLP is a legal entity in which
the partners are family members. An FLP requires at least two partners, who each
contribute assets (hence the term "donor"). At least one of the partners (either
one of the donors or a corporation owned by the donor) must be a general partner. An
important requirement is that an FLP must generally operate as a trade, business,
investment or income-producing venture. The partnership cannot be an S corporation
shareholder, and problems are associated with the partnership owning voting shares of
stock of a corporation controlled by the general partner.
General and limited partnership interests are exchanged
for a transfer of assets. Usually, each general partner receives a 1% general interest,
and issues the remaining interests as limited partnership units. General partners transfer
these units to recipients by using the unified gift and estate tax credit and the annual
gift tax exclusion.
The general partners control the FLP’s assets by
making all investment, business and management decisions, while transferring up to 98% of
the value of the partnership to children, grandchildren or other family members. The
general partners determine the cash distributions to limited partners. They also have
fiduciary responsibility to the partnership and must handle all transactions at arm’s
length. In payment for these services, the general partners should receive a reasonable
management fee.
The limited partners have no control over investment,
business and management decisions. Generally, the partnership agreement prohibits them
from unilaterally removing assets from the partnership (via distributions or otherwise)
and from forcing its liquidation. The limited partners can be taxed on up to 98% of the
partnership income at their appropriate (often lower) tax rate.
Common Nontax Reasons For
Establishing an FLP
Most of those who establish an FLP do so because they
wish to:
Retain control over transferred assets.
The most common reason for establishing an FLP is to give children or other beneficiaries
an interest in valuable property without surrendering control over that property. By
making beneficiaries limited partners and assuming the role of general partner, those
establishing the partnership maintain control over its income and assets.
Protect assets from creditors. A
partner’s creditors are only entitled to a claim against his or her partnership
interest, not the underlying assets. These interests are often unattractive to the
creditors and difficult for them to access. Also, the partners can be insulated from
exposure to the partnership’s creditors.
Protect assets from marital claims. An FLP
arrangement can help partners avoid these same difficulties in the event of marital claims
against them.
Increase the size and scope of assets. The
partnership can allow family members to create a larger pool of assets, reducing
management and administration costs and increasing diversity.
Maintain continuity of business interest
and investment philosophy. The head of a family can establish an FLP to allow a smooth
transition of assets to successors. This can provide a longer time horizon for
investments.
FLPs Can Be Powerful Financial
Planning Tools
To set up an FLP, you may need an appraisal of the value
of the underlying assets, such as real estate, and an appraisal of the appropriate
minority and lack of marketability adjustments. These adjustments result from the
restrictions on the limited partners’ control of the assets. Expert advice is
important to avoid later problems with the Internal Revenue Service or in case disputes
arise.
Genuine benefits are usually accompanied by time and
money requirements. The FLP requires some effort, but also offers powerful potential as a
way to transfer wealth while enabling the older generation to retain adequate control over
the management and growth of these assets.
These powerful financial planning tools will help you
preserve your assets. Call us today to learn more about setting up an FLP to protect your
financial future.
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