Using Family Limited Partnerships for planning estates
Transferring assets from one generation to another is a complicated affair. A taxpayer can reduce his estate tax liability through gifts of cash and assets. But immediate and absolute gifting is a two-edged sword: one edge may ensure a larger estate to heirs while the other brings the loss of control over transferred assets. So, then, how may the taxpayer both reduce his estate tax liability and still maintain control over his assets?
The answer is a Family Limited Partnership (FLP). The Family Limited Partnership works to allow the parental generation to maximize gifts during their life, while still maintaining control of cash assets. The Family Limited Partnership structure allows the taxpayer to shift his assets, along with their appreciation and income, to possible lower tax-bracket children and grandchildren. And yet, while these junior generations obtain interests in the assets, their liability for partnership debt is strictly limited to their interests in the assets of the partnership.
Additionally, partnership assets receive protection from creditors of the partners. Unlike the irrevocable trust, the Family Limited Partnership is an ideal substitute because of its flexibility. For these and other reasons, the Family Limited Partnership remains the entity of choice for many business and estate planners.
Typically, the parents make a nontaxable transfer of assets to the partnership in exchange for partnership units. The partners then begin the systematic gifting of limited partnership units to junior generation members, bringing the junior generation into the partnership.
The Partnership Agreement limits transferability of limited partnership units and the owners of these units do not exercise management control over the Partnership. Consequently, the value of each unit is reduced or “discounted” to a value less than the actual share value of the Partnership assets.
Control rests with the general partner, usually the parent, who manages the partnership activity as well as assuming personal liability for the partnership’s debts and obligations. The limited partners have no responsibility in managing the partnership, and their liability is limited to their interest within.
The goal of the parent is to gift away the largest portion of the Partnership, in limited partnership units to the junior generation, while still retaining a controlling interest as a general partner. This allows the parent to remove the maximum amount of the value from their taxable estate while preserving control over partnership activity.
The Family Limited Partnership offers a number of tax and non-tax advantages. One benefit is that the Family Limited Partnership serves as an important estate planning tool whereby property may qualify for “valuation discounts”. Valuation discounts allow the asset holder to leverage the annual gift tax exclusion and unified credit, allowing parents to transfer more assets to the junior generation with considerably reduced gift and estate tax liabilities. Another benefit is that the Family Limited Partnership allows the parents to shift a portion of income earned by their closely-held business to other family members, while at the same time retaining control over that business.
As general partners, the parents maintain control over distributions of income to partners and, as a result, determine the timing and amount of income distributions made to the junior generation. In conclusion, when an individual contributes assets to a limited partnership in exchange for an interest in that partnership, the contributor no longer owns those assets.
Therefore, the transfer of assets limits the ability of a creditor to attach the assets themselves. A creditor may obtain a “charging order”, which assigns the creditor the partnership profits allotted to the limited partner. The creditor’s interest is restricted to the right to receive profits when distributions are made.
Family Limited Partnerships