When a family business is passed from one generation to the next, estate taxes often inflict a heavy burden. One succession strategy to eliminate this problem is to give your children shares of the company while you're still alive through the use of a family limited partnership (FLP).

With this estate planning tool, you’ll not only keep the business in the family, you also will be able to retain control and collect huge breaks on gift and estate taxes. Here are the ways to accomplish this:

Get a professional valuation of assets to be transferred to the partnership. The IRS, on occasion, challenges these transactions, its main argument being that the value placed on the assets at the time of their transfer to the partnership.

Create an FLP and transfer your business, rental real estate or other valuable assets into it in exchange for the ownership interests in the partnership. You should start by being both general partner and the initial limited partner. Legal title of the assets must be changed to reflect the transfer.

Bequeath gifts of all or most of the limited partnership interests to your children or other heirs. You retain the general partnership interest, which is about 1% of the total value. In doing this, you retain control over the business or property. Under partnership law, limited partners have little or no say as to how the assets are managed. As the general partner, you can also draw a salary. However, you aren't considered the owner, therefore only the value of the partnership interests you still own when you die will be included in your estate.

Here's the main advantage of an FLP: when you make gifts to your children, you can claim valuation discounts between 20 and 40 percent. In effect, you're saying that each piece of the family business you are giving away via a limited partnership interest is worth less because the recipient has limited power and liquidity.

By using valuation discounts and the annual gift tax exclusion, an FLP becomes the foundation of a family gifting program. You are allowed to give $11,000 a year ($22,000 for married couples) to as many recipients you’d like without any gift tax consequences. With a series of gifts, you are able to transfer all or most of your company out of your taxable estate.

Warning! : for a family limited partnership to pass IRS scrutiny, there has to be a business purpose. Also, you should also keep in mind that IRS auditors crack down on valuations they consider to be too aggressive.

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.