A family limited partnership (FLP) is simply a limited partnership structure designed to allow senior family members to own a small share of the value of a business. It also allows them to maintain control (often temporarily) while selling, transferring, or giving away much of the value of the business—often at a discount—and to share in the growth in value of the company.
FLPs have the added advantage of allowing selected members of the next generation to maintain control and management of a larger business while permitting some financial benefits to go to family members who either don’t work in the business or who are just learning the business.
Benefits of an FLP
There are a number of reasons that wealthy families and individuals utilize FLPs as a valuable and highly effective tool in the estate planning toolbox.
Maintaining Control of a Business
One of the most common purposes of the FLP is to allow the senior generation family members (the general partners) to retain control and management of the family business and its assets while the younger family members (the limited partners) learn the business so they can eventually run it themselves.
Parents always have the option to give away their estate while they are still alive; however, by doing so, they lose control of assets and management of the business, so they will not be able to protect either from unintended beneficiaries.
Through the creation of an effective partnership agreement, the FLP can state how the business is to be distributed to partners for purposes of a smooth transition.
Providing Asset Protection
Another common purpose of the FLP is to protect family assets. Assets owned by the limited partnership belong only to the limited partnership. Therefore, any personal liability created by individual decisions or actions of a partner will not affect the partnership’s assets.
The partnership agreement can provide additional protection by defining what partners can and cannot do. This asset protection stops creditors from seizing the partnership, interfering with management of the partnership, demanding a partnership distribution of income or assets, or terminating the partnership.
Reducing Taxes
When done properly, the FLP can drastically reduce estate taxes, especially for businesses where the estate assets are investment real estate used for family business purposes.
Under an FLP, the general partners can make a gift of the limited partnership interest to their children or to a trust for their children. This allows parents to shift their assets out of their estate but maintain control without full ownership.
The IRS also allows transferred interests in limited partnerships to be discounted to reflect their true value in the market. These discounts can range from 20 – 50%. This means that interests can be given away while using less of one or both spouse’s unified estate and gift tax credits.
Earning Discounts
There are several reasons an FLP can be discounted, and there are a number of discounts available.
First, while FLPs are similar to stock in a corporation, they are not as valuable as stock because they are not traded and, as such, cannot be easily sold. For this reason, they are often discounted when transferred based on a lack of marketability discount.
Second, the limited partner has no right to participate in management and, therefore, cannot control decisions that affect business income and profitability. Hence, the value of the limited partnership interest transferred to children, grandchildren, or trusts for them is lower due to a control discount. As a result, the size of the parents’ estates and the amount of estate tax liability is reduced.
Finally, after the gift of any limited partnership interests, all of the growth of the company value attributable to the limited partnership interests takes place outside of the parents’ estates and builds in the value of the limited partnership interests.
This can go a long way toward fixing the problem of children helping to build the value of a company that they have to buy and/or pay inheritance or estate taxes to acquire.
Establishing an FLP
Establishing an FLP is best done by working with a team consisting of a law firm, a business appraisal firm, and an accounting firm, all of whom should be experienced in the creation of business entities and their use and valuation in trust and estate planning.
There are numerous lifetime, business governance and tax issues as well as state and federal death tax issues involved in creating and transferring FLPs. So, having the lawyers, accountants, valuation experts, and financial advisors all on the same page is essential.
This team will be responsible for preparing organizational documents and transferring ownership of assets to the limited partnership. They also will transfer ownership interest in the limited partnership either directly to the heirs or to trusts for their benefit (which can add better creditor protections and potential future estate tax savings).
Finally, the lawyers and accountants may need to file gift tax returns and will certainly file annual income tax returns for the family limited partnership. For that reason, it is again best to have them all on board at the time of creation and funding of the FLP and gifts of FLP interests to trusts.
Typically, and ideally, you will create an FLP to own and operate either an existing family business or to build and develop a totally new business, product, or service. In many ways, which is ideal. Once you realize that you have a new business, product or service to offer and that it could be profitable, it’s best to do it right from the start in an FLP so that the value of all growth is carried out to the heirs rather than built up in your own estate where it could later be subject to estate or gift taxes.
Remember, anytime you gift shares of an existing business you’ll need to get appraisals or valuations (including minority discount and marketability discount appraisals) so that you can file a gift tax return.
But, when creating a new business or product / service line in a new FLP, you may want to have the heirs or their trusts “buy in” right from the start at very low prices, allowing all of the gain in the business to occur outside of your estate.
Who Should Use an FLP?
FLPs have many advantages, and anyone owning a closely held business and/or real estate (especially real estate used in a family business) should consider this technique to protect, preserve and pass on such assets to both children working within the business and those working outside the business. It may also be appropriate for other types of assets that you wish to maintain control of but would like future appreciation to occur for a portion outside of your estate.
Example
Let’s say a husband and wife run a successful dry-cleaning business, and they want to transfer the assets and management of the company to their two children in the future. Their daughter currently works at the company, but their son is employed elsewhere.
The FLP agreement can give their two children a share of the business through their limited partnership interest. In addition, the daughter can receive a salary for her actual work in managing and growing the business. She can also assume the role of a general partner upon the death or retirement of one or both parents while the son who does not work in the business could get a share of the value of the company and an income distribution of the profits.
If you or a friend or family member would like to explore setting up an FLP as part of a comprehensive estate plan to preserve intergenerational wealth, please contact us at (760) 448-2220 or via our website at https://www.geigerlawoffice.com/contact.cfm.
