FLP a good Estate Planning tool?
Recently, Family Limited Partnerships (FLPs) have come into vogue, although they have been a useful estate planning tool for over forty years. The reason for the popularity of Family Limited Partnerships is because of a 1993 IRS clarification that specifically authorized the ability to consider gifts of stock to family members eligible for minority discounts.
A Family Limited Partnership may provide significant advantages in the following areas:
· Reducing gift taxes
· Reducing estate taxes,
· Facilitating family succession
· Protecting assets.
In creating a Family Limited Partnership, the parents put their assets into a partnership and then give a minority interest to other family members while they (the parents) still retain control of the assets. Through a Family Limited Partnership, the parents can shift wealth to their children, introduce them to asset management, educate them about investments and wealth, facilitate and manage pooled resources, and achieve different economies of scale.
According to an attorney who specializes in FLPs, children can also manage their parents’ assets through a Family Limited Partnership instead of a revocable trust. In this application, the children are the general partners and the parents are the limited partners. The parents will own a greater share of the assets and consequently receive most of the income stream, but the children manage the assets for the parents. When the parents die, those assets can be distributed without going through probate.”
The ability to take discounts on partnership interests in a Family Limited Partnership is a great gift tax and estate tax planning tool. As with any limited partnership, those holding a partnership interest in a Family Limited Partnership cannot participate in partnership activities. For instance, under a number of states they can’t make investment decisions, decide when to make distributions, force the partnership to buy their interest, or dissolve the partnership. Because of these restrictions, minority interest discounts and lack of marketability are applied to the minority interest. This ability to take discounts allows larger gifts of wealth and estate planning to reduce gift and estate taxes.
Let’s assume two parents both own $1 million in real estate, stocks, bonds, etc. They create a Family Limited Partnership and receive all of the general interest and limited partner interest. Each parent owns 50%. If they each gave away 1% of the assets, that would be $10,000 each. However, if they gave away 1% limited partnership interest, with the value discounted by 50%, each of the parents could distribute $20,000. There are no additional gift taxes when the child sells the assets, even at the higher actual value, because they don’t look back for gift taxes.
The parents are able to give more assets away each year, shifting wealth out of the estate. This is especially important when the estate is too large to effectively be reduced through traditional gifts of the assets. Think about the uncle with a $3 million estate. He is entitled to an estate tax credit of $600,000, which he gifts in equal amounts to three nephews. The uncle and nephews put all of the $3 million into a Family Limited Partnership. The uncle owns $2.4 million and the nephews own the rest. The nephews are the general partners. Upon the uncle’s death, all that is in his estate is $2.4 million less than the discounts. For illustrative purposes, assume a 50% discount. The uncle’s estate is valued at $1.2 million. Now the nephews only pay estate taxes on $1.2 million instead of $2.4 million.
Had there been no Family Limited, the estate would have enjoyed a step-up in basis to the full amount upon the uncle’s death without capital gains. In the Family Limited Partnership, only $1.2 million is included in his estate, so only that amount is stepped up. The capital gains tax would have to be paid on the difference between the discounted basis and the actual face value of $1.2 million. However, that is preferable because the capital gains tax caps at 28 percent ($336,000) compared to estate taxes approaching 45% ($540,000).
Warning: The IRS is watching you!
It should be noted that these discounts are being closely watched by the IRS. Recently, congress passed new tax laws that allow the IRS to ignore certain paper discounts for gift tax and estate tax purposes if the family controls the limited partnership and could dissolve the partnership immediately after the transfer of assets. But there are a number of states having laws protecting discounts being applied by Family Limited Partnerships, and these laws cannot be ignored by the IRS. Therefore, a Family Limited Partnership is able to take a discount if properly defined under state law, but the question from an IRS audit remains “how much is too much?” Usually, discounts in the 30-45% range are taken. If an individual has a goal to get a 60% discount or more, he’ll have more exposure, but in many cases, there is ample justification.
Facilitating family business succession
Assets included in the Family Limited Partnership can also influence family succession of a privately owned business. For example, an owner wants to expand the manufacturing plant of the business. Even if the owner retains all of the control at first, he can pass the business on to a child involved with the business and equalize values for other uninvolved children through gifts of interests in the Family Limited Partnership.
Protection of assets
Under the assumption that a business owner has personally guaranteed loans for the business by putting stocks and individual liquid assets into a Family Limited Partnership with his spouse as a general partner and the business owner as a limited partner, the assets are protected. If the bank should call in the personal guaranty, it will receive the business owner’s limited interest. As a limited partner, the bank is taxed on income associated with the limited partnership even though there may not be any cash distribution. The bank can’t force distribution and is unable to liquidate the assets. The bank will soon want to negotiate out of the limited partnership.
The bottom line: Is a Family Limited Partnership a good choice for you?
If your estate is over $1 million and you want to minimize taxes through estate planning, then having a Family Limited Partnership might be the best tool for you. It’s strongly suggested that you see your attorney for a complete analysis of your personal situation.
Family Limited Partnerships