A Family Limited Partnership (FLP) has become a popular business unit for wealth management, minimizing taxes and maximizing the transfer of wealth.

Family Limited Partnerships have helped taxpayers remain in control of their wealth even following the transfer of it to their loved ones. In addition, a number of these transfers were made at a significant reduction which further leveraged wealth transfer tax savings. Therefore, it is no surprise that while FLPs have been employed as a planning cure-all by taxpayers, they have also been looked upon with distaste by the Internal Revenue Service as well as some courts.

What a Family Limited Partnership actually is a Limited Partnership among family members. The creators of an FLP are usually the parents, who are initially both the General Partners (GPs) and the Limited Partners (LPs) while they simultaneously contribute assets to the FLP. The larger share of contributed assets is thereafter assigned to the LP shares. Nevertheless, the GPs hold all of the management control over the FLP assets.

When the Family Limited Partnership assets generate income, then the General Partners are entitled to be compensated for their managerial services. Limited Partners enjoy an ownership interest only and they have limited authority along with restrictions on the transferability of their LP interests. This lack of control along with the inability to transfer the LP interests freely reduces the FLP asset’s value. In turn, this discounting will enable the parents to transfer more wealth along with the future appreciation of that wealth through their LP interests to younger family members, yet retain lifetime control over that wealth.

The other benefits include splitting up income and asset protection, since the Family Limited Partnerships income may be spread among several family members and creditors of the LPs may be limited in their attempts to reach the underlying FLP assets.

Given the powerful tax and wealth transfer benefits available through Family Limited Partnerships, it is no small wonder understand why the IRS as well as some courts hate them. So, first and foremost, a Family Limited Partnership has to be created for a business purpose and not just for estate planning.

Some examples of selfish behavior in regards to Family Limited Partnerships include taxpayers establishing deathbed FLPs as well as taxpayers transferring to their FLPs a substantial amount of their personal assets and means of financial support, thereby leaving themselves with no other source for income and sustenance.

As some may already guessed, in addition to the Family Limited Partnership’s business purpose, the IRS has scrutinized the valuation discounts which are claimed by the taxpayer for the Limited Partnership interests. When these gifts are made, the taxpayer has to ensure that any discounts attributed to the gifts are authenticated in writing by an suitable valuation expert and that these discounts are reported on a timely gift tax return.

It should be noted that not everyone wants a Family Limited Partnership. Between legal fees, valuation fees, required state filings and reports, and tax returns (for the Family Limited Partnership, the General Partnerships and the Limited Partnerships), FLPs will require considerable commitment in both time and resources. Along with the increasing IRS and judicial scrutiny, even the once-favored tax treatment of a Family Limited Partnership is in a state of instability.

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