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Family Limited Partnerships

A Family Limited Partnership (FLP) is a special legal vehicle that can preserve a family business for future generations while helping to shelter assets and reduce overall gift and estate taxes by facilitating lifetime giving. FLPs are commonly used as part of business succession planning, business continuity plans, and often serve as an integral component of an estate plan for high net worth individuals.

A Family Limited Partnership is typically established by an individual who places assets in the FLP and serves as its general partner.  He or she may then grant limited-partnership interests to his or her children or grandchildren.  When this occurs, the gifted assets are removed from the general partner’s estate, thus saving on future estate taxes.  The general partner keeps control of the FLP and its assets, even though he or she may own as little as just 1% of the asset’s value.  Where an individual is willing to transfer control to his or her children or grandchildren, the FLP may be used to transition control of family assets to the next generation without having to make gifts of particular assets to each family member.

Limited partners may receive distributions from the FLP and enjoy certain tax benefits. Asset protection is another attractive feature of the FLP. The partnership’s assets are shielded from the limited partners’ creditors. The interests in a FLP can be easily divided among family members, who may each own different amounts. The FLP enables ownership of a business to transfer to the younger generation, while allowing the senior generation to continue conducting operations and mentoring and grooming the young owners.  Additionally, a FLP may provide protection from spouses (or former spouses) and creditors of the next generation.

One of the significant benefits of a properly established and maintained FLP is that it can reduce the value of gifts to your children and grandchildren. The value of each limited partnership interest which you give away decreases the value of your taxable estate and, consequently, any tax which your heirs would have to pay upon your death. The gifts are made using the annual gift tax exclusion, so you may not have to pay any gift tax on the transfer.

The value of the partnership interests transferred to children and grandchildren should be appraised so that the gifts may be properly reported.  So long as the value of the gift does not exceed the annual exclusion amount (currently $14,000 in 2016), the gifts may pass to the beneficiaries without incurring any gift tax or using any of your estate tax exclusion amount.

With these significant benefits, it’s no surprise that many FLPs have attracted scrutiny from the IRS. Many have run into various problems due to mistakes or outright abuse by taking large valuation discounts. Care must be taken to ensure your FLP is properly established and operated. Specifically, the IRS may look at the following issues when assessing the viability of the FLP:

  • A FLP should be formed for a significant, legitimate non-tax-related reason. Tax savings are an important consideration, but you must be able to demonstrate that there are other reasons, as well.  
  • Personal assets should not be transferred to a FLP. You can reasonably expect to transfer closely held stock or interests in commercial real estate into a Family Limited Partnership. However, personal property such as cars or residences will not fare well against an IRS challenge. Similarly, the FLP’s assets should not be used to pay for any personal expenses. The FLP must be a legitimate business entity operated to fulfill a business purpose.  
  • Assets transferred to a FLP should be professionally appraised, and gifts of limited partnership interests should also be appraised. Partners or family members should not determine the valuation of any assets transferred into the FLP. A qualified appraiser has a much better chance of withstanding IRS scrutiny.  
  • Don’t push it. Many peopleare tempted to put as many assets into the FLP as possible, to maximize the asset protection and tax savings benefits. Unfortunately, if the FLP is successfully challenged, a significant portion of a partner’s net worth could be vulnerable to taxes or lawsuits.A FLP should only be one component of your well-drafted estate plan.

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