How Family Limited Partnerships (FLPs) work
In most Family Limited Partnerships, the parents (or an entity that is owned by the parents, such as an S corporation) are designated as the general partners, either concurrently or successively. This allows them to maintain control over the partnership assets. The children and/or grandchildren are designated as limited partners. The parents can also own limited partnership interests and are capable of transferring some or all of their interests to their descendants over a period of time through gifts or other means to save estate and income taxes.
If the parents no longer want to serve as general partners, the position of a general partner can be passed on to someone else, thereby providing continuity of management and family training.
The Family Limited Partnership is a practical vehicle for consolidating assets and providing long-term accumulation of wealth while at the same time affording a positive method of control. In general, assets such as real estate and/or marketable securities can be transferred to an FLP on a tax-free basis. The FLP prevents having to divide the assets to heirs at death, including the real estate and/or marketable securities, since the heirs inherit an interest in the FLP, not the specific assets themselves.
The FLP also eases the transfer of assets by gift or other ways, since partnership interests are transferred rather than undivided fractional interests in real estate or specific shares of stock.
FLP basic information
Family Limited Partnerships (FLPs) are without a doubt the most powerful tool in an estate planning arsenal. However, it could also be the most dangerous! Family Limited Partnerships are used in conjunction with other tools and, in order to avoid IRS scrutiny, they have to be very precisely implemented and operated.
The family limited partnership’s power comes partly from the wide range of benefits that can arise:
Charging Orders and Foreclosures are both tools creditors may use to try to get around this shield. One point stands out, and that is a Family Limited Partnership interest should never be held directly by an individual. The interest should be owned by a trust.
A Family Limited Partnership is a partnership comprised of at least one general partner, who remains liable for partnership obligations, and one or more limited partners having limited liability. The general partner is the one who makes decisions on allocating income. A partnership is not taxed as such; the partners are taxed on the portion of income allocated to them. Therefore, the general partner has the responsibility of allocating to lower-bracket limited partners.
It is a well-known fact that a minority interest in a partnership or corporation is worth less than its pro-rata portion of the overall value. For example, if a partnership is worth $1 million, the pro-rata value of a 10% interest would be $100,000.
However, because that 10% interest does not have the ability to control the affairs of the partnership and is not very marketable, usually it is used to reflect the lack of control and marketability by discounting – sometimes in the vicinity of 30-40%. Consequently, the value in our example of a 10% interest might be discounted by $30-40,000 and, therefore, worth between $60-70,000.
It is obvious that expert business valuation is necessary to establish the discounted value acceptable to the IRS and that value needs to be kept up to date during an ongoing gifting program.
There isn’t any way to detail all the points and problems encountered with family limited partnerships. However, here are a few things that might come up in discussion:
Form the partnership earlier rather than later, hopefully when you are in good health, and document the partnership’s purposes.
Establish the partnership correctly under the laws of your state of residence and operate it in a businesslike manner. Always ensure that you file returns and reports in a timely manner, have a taxpayer ID, have separate books and records, hold required annual meetings with proper reports and disclosures to the partners;
Only Business and not personal assets should be transferred in. In all likelihood, not all assets will go in. It is also probable that you will retain enough to enable yourself to live without needing to rely on partnership distributions, You should also distribute income according to partnership interest rather than meeting the living needs of a general partner;
There is a possibility an investor will not be a general partner. The less that the investor appears to be in control, the stronger the family limited partnership.
On the whole, the family limited partnership is a very powerful tool. However, once again, it is one that needs a lot of advice to plan and operate carefully.
Family Limited Partnerships