A Family Limited Partnership (FLP), like other limited partnerships, is a form of business that consists of one general partner and one or more limited partners. But, in a Family Limited Partnership the individuals who are involved are typically members of same family. One advantage of a well-executed Family Limited Partnership is reducing federal estate and gift taxes. Instead of having to transfer assets directly to beneficiaries, an individual may transfer interests in a limited partnership. Since the interest in a Family Limited Partnership is not marketable and a limited partner is not in control of the enterprise’s management, the value of a Family Limited Partnership’s interests usually can be discounted from 25% to 50%, with a corresponding reduction in tax liability.

As with a number of transactions involving family members, the IRS has a history of casting a cynical eye on Family Limited Partnerships. For all intents and purposes, the objective of the IRS on assuring that tax advantages of any particular Family Limited Partnership are not the be-all and end-all for its existence. If the Family Limited Partnership is believed to be a fraud, then the IRS may challenge the valuation discount and even the very existence of the partnership.

Recently, a federal appeals court found a Family Limited Partnership to be legitimate in spite of some circumstances that had made the IRS suspicious. A 96-year-old woman has placed over $2 million into a Family Limited Partnership, while setting aside $450,000 for her personal expenses. She passed away two months later. What weighed in favor of the Family Limited Partnership was the fact that the transfer included interests which required active management and no personal assets, such as a house or car, were involved. Another factor was that when making the transfer into the Family Limited Partnership the woman did not manage the partnership herself. Most important of all, the woman’s oil and gas operations provided an essential legitimate business purpose for the Family Limited Partnership.

In another case similar in many respects, including the age of the person who transferred the assets into the Family Limited Partnership, the assets were found to be subject to the estate tax because the Family Limited Partnership had not been formed for a valid business purpose. The Family Limited Partnership transactions never went outside the family circle and amounted to provide for the financial needs of individual family members.

What emerged from these cases are a few general “rules of thumb” in setting up and running a Family Limited Partnership to realize its tax benefits without attracting the IRS’ attention:

· Communicate the real business reasons for the Family Limited Partnership that can be substantiated by people outside the partnership;

· Never allow the person transferring assets into the Family Limited Partnership transfer all of his assets or use the partnership to pay personal expenses;

· Assign control over the Family Limited Partnership to a general partner who is not the same person funding the partnership. Often the general partner is an entity, such as a limited liability company;

· Have some actively managed assets in the Family Limited Partnership

· Follow all formalities for the set up and operation of the Family Limited Partnership. This includes separate accounts and scrupulous adherence to formal accounting practices.

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