A Family Limited Partnership (FLP) is a partnership having a general partner and at least one limited partner. Family Limited Partnerships are designed to address several purposes: convenient administration of investments while, at the same time retaining control, as a vehicle for annually transferring gifts for tax planning purposes. In addition, Family Limited Partnerships provide creditor protection for limited partners. This article takes a look at these aspects of Family Limited Partnerships.

Retaining Control

A standard Family Limited Partnership is established by an older family member who transfers business or investment assets to the partnership. The general partner has considerable control over the business activities of the partnership, making investment and management decisions and determines when distributions should be made to the limited partners. This determination centers upon the general partner's evaluation of the needs of the partnership operations. Often, the senior family member serves as general partner. However, as we shall see, that is not always the best way to structure the Family Limited Partnership.

Allocating Profits

The Family Limited Partnership’s taxable income is reported annually and allocated to each partner on the basis of that partner's percentage interest. The allocation is noted on the Form K-1 issued to each partner. Ordinarily, the general partner annually distributes at least enough money to pay the income tax liability attributable to each partner. Distributions aren't taxable to the extent the partner has basis in the partnership interest. Unlike a corporation, the partnership itself is not subject to tax, because it passes through all items of income and deduction to the partners.

The Individual or Corporate General Partner

The general partner can be either an individual or a corporation. The general partner is entitled to receive compensation or a fee for management services performed. That fee is included in the income of the general partner and is subject to payroll tax.

Family Limited Partnership Uses

Annual Gifts

A Family Limited Partnership can be the foundation of a family gifting program under which partnership interests are transferred to the senior family member's spouse, children, grandchildren or trusts for their benefit.

Every U.S. resident is allowed to gives gifts up to $10,000 annually to any donee. This is the same for spouses, thereby increasing the annual exclusion to $20,000 per year per donee. This annual exclusion can be leveraged by claiming discounts on the value of the limited partnership interest gifted because of minority interest and lack of marketability discounts at the time of gift. These discounts are permitted due to the lack of control and restrictions of transfer usually associated with limited partnership interests in the Family Limited Partnership. This leveraging can play an important role in a senior family member's estate planning, for the most part, when the tax savings on any future appreciation of gifted property is considered.

Estate Tax Benefits

The same discounts used to reduce the value of gifts made during life also apply to reduce the estate tax value of transfers of FLP interests at death. The estate tax savings for claiming lack of marketability and minority interest discounts can be substantial. The percentages allowed for these discounts vary from situation to situation.

Protection from Creditors

The general partner of a limited partnership bears complete personal liability for the Family Limited Partnership’s debts, to the extent that partnership assets are insufficient to pay partnership debts. The general partner can avoid personal liability through the use of a corporation (for example, a Subchapter S corporation) to hold the general partner interest.

While creditors can reach the general partner’s personal assets, by contrast a limited partner bears no liability for debts of the Family Limited Partnership beyond the limited partner's interest in the partnership. Generally, the only right a creditor would be able to obtain against a limited partner is a "charging order" against the limited partnership interest. This allows the creditor to receive the limited partner's share of partner income. A charging order is not always beneficial to a creditor, since the creditor receives a form K-1 from the partnership which requires the creditor to report as taxable income the limited partner-debtor's share of partnership profits, whether distributed or not.

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.