A partnership is a consensual arrangement involving two or more people to join together to engage in a business or other profit inspire activity. A limited partnership is a partnership where at least one partner's liability is limited solely to the assets contributed by the partner to the limited partnership, and that partner is barred from participating in day-to-day management of the limited partnership. A Family Limited Partnership (FLP) is a limited partnership where most or all of the partners are family members.

Although there are numerous technical requirements that must be adhered to in order for a Family Limited Partnership to meet the requirements of the IRS, a Family Limited Partnership, if properly structured and administered, provides a number of benefits in the estate and gift tax arena. Because of costs involved in creating and maintaining a Family Limited Partnership, it is not a strategy that is attractive to everyone notwithstanding the claims of many sellers of Family Limited Partnership arrangements.

From an estate planning point of view, the most attractive aspects of using a Family Limited Partnership is the availability of various valuation discounts, such as lack of marketability and minority interest discounts, to depress the value of limited partnership interests that are gifted to family members or trusts for the benefit of family members. Often, there are those who are able to reduce the value of the assets conveyed to a Family Limited Partnership by 30%. In other words, if $2 million of an individual’s assets were transferred to a properly structured Family Limited Partnership in return for partnership interests, the Family Limited Partnership’s value of the interests received by the individual have a value, for transfer tax purposes, of $1,400,000 or less.

Another benefit of using a Family Limited Partnership is the ability of senior family members to retain control of the management of the Family Limited Partnership and the money generated by it. Using a Family Limited Partnership provides some protection from future judgment creditors.

In general a Family Limited Partnership is formed all partners entering into a formal limited partnership agreement and filing a certificate of limited partnership with the state agency that is designated under state partnership law. The initial and annual filing fees vary from state to state. Additionally, state laws governing certain aspects of limited partnerships will vary from state to state.

There is one type of assets that should not be transferred to a Family Limited Partnership. One example is stock in an S Corporation transferring S Corporation stock to a Family Limited Partnership causes the termination of the S election. What is more, there may be undesirable estate tax consequences when funding a Family Limited Partnership with stock in a closely-held corporation if the person transferring the stock is the sole or managing general partner of the Family Limited Partnership and the transferor owned at least 20% percent of the voting stock of the closely-held corporation.

When appreciated marketable securities are transferred to a Family Limited Partnership, no gain will be recognized unless more than 80% of the non-cash assets of the Family Limited Partnership consist of readily marketable securities and the transfer results either directly or indirectly in diversification of the interests of the transferor. A transfer generally results in diversification of the interests of the transferor if two or more people transfer non-identical assets. Generally, this problem will not arise if a multiple stock portfolio is contributed by one partner and the other partners transfer cash assets exceeding 1% of the value of the total assets transferred to the Family Limited Partnership.

Because most families establishing a Family Limited Partnership for estate planning purposes hope to obtain the substantial benefit of the available valuation discounts, it is necessary that several significant costs will be incurred. One vital cost involved in forming a Family Limited Partnership is the fee paid to the law firm advising and counseling the family and drafting the actual limited partnership agreement. The necessity of this cost is because of the valuable expertise needed in order to avoid multitude of traps for the unwary contained in the income tax provisions, the estate tax provisions and the special valuation rules of the Internal Revenue Code.

Another significant cost is the fee paid to the business assessment firm that values the partnership interests to be gifted to other family members, such as children, grandchildren, nieces and nephews. Failure to obtain a comprehensive business valuation from a professional business valuation firm containing the analyses required by federal tax law results in uncertainty as to the probable value of the partnership interest transferred to other family members. If partnership interests gifted are undervalued, penalties and interest, along with unexpected taxes, may be due and owing. If partnership interests being gifted are overvalued, the transaction fails to provide the full tax savings that would be available with the proper use of the valuation discounts. Additional appraisals prepared by other appraisers, such as real estate appraisers, may also be needed, depending on the types of assets transferred to the Family Limited Partnership.

The initial and annual filing fees must be paid to the applicable state agency, and annual accounting fees for preparation of an annual partnership income tax return, are also costs that need to be taken into account for those considering forming a Family Limited Partnership.

Finally, using a Family Limited Partnership in conjunction with estate and business planning can be a viable tool that results in significant reductions in transfer (gift, estate and generation-skipping) taxes. Then again, the proper implementation of a Family Limited Partnership is a complex and sophisticated endeavor requiring use of experienced professionals who have the understanding of the numerous state and federal law requirements along with the ability to identify all the issues and to assist their clients in properly resolving those issues.

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.