What is an FLP?

First of all, a limited partnership is a type of business organization recognized in most states where management rights and responsibilities are vested in one or more general partners while the ownership interests are vested in limited partners. A limited partnership is a flow-through entity for income tax purposes, which means that the partners pay income taxes or enjoy tax benefits individually, based upon their ownership interest in the partnership. A family limited partnership is not a different type of business organization. Instead, it is used to describe a limited partnership where most or all of the general partners and limited partners are related to each other.

Who sets up an FLP?

Usually families with business assets which they desire to own in common, including assets which some family members wish to pass on to other family members, benefit from an FLP. For example, parents owning all or most of the interest in a store who want to involve their children in the ownership and management of the business may benefit from setting up an FLP. What the FLP does is to allow the family to have flexibility in dividing the store’s ownership and control in ways which will work for its members. Inasmuch as the organizational costs can be substantial, families having business assets which total less than $1.5 million rarely find it to their advantage to establish an FLP.

What type of assets work in an FLP?

Any kind of business or investment assets work in an FLP. Assets connected with an operating business, such as a store or ranch, usually work particularly well, but some families establish FLPs solely with investment-type assets. Personal assets, such as homes and furniture, should not be placed in an FLP. Retirement accounts, such as IRAs and 401k plans, usually don’t work in an FLP.

What are the benefits of an FLP?

Among the benefits are:

Centralization of Management – An FLP fractionalizes ownership while management remains centralized.

Facilitating Intra-Family Transfers – FLPs ease the transfer of interests in family business assets from one family member to another. For example, a parent would be able to transfer a specified percentage of a collection of business assets (in other words, an interest in the FLP) to each child, rather than multiple transfers of specific assets.

Discounts - In most cases, the FLP interests owned or transferred by a family member are valued at less than the underlying assets would be valued if the partnership did not exist, possibly saving transfers taxes.

Avoiding and resolving family disputes – FLPS provide a means to resolve existing or future family disputes, thereby making it more likely to avoid these disputes entirely.

What are some of the drawbacks of FLPs?

Among the drawbacks are:

Organizational costs -- Setting up an FLP costs $5,000 or more, so the potential advantages need to outweigh this up front cost.

Operating requirements – The FLP has to be operated as a separate business, with separate bank and investment accounts and separate tax returns. The FLP form must be respected, which means changes from prior family practices. Personal and partnership finances must be kept separate. Most people aren’t willing to make these changes, and FLPs are not for these people.

Tax scrutiny – The IRS scrutinizes FLPs for estate and gift tax purposes because the agency does not like the discounts many FLPs receive. Therefore, families should be prepared for this type of scrutiny when gift and estate tax returns are filed.

If you would like more information regarding asset protection, trusts, family limited partnerships or the subject of this article please call or email our office.