Many people want to enrich their children and grandchildren with their wealth, possessions, and business interests which they own. The problems in the past have been inability to control the assets once they were given and the potential of facing estate tax issues when assets are substantially appreciated. The device known as “The Family Limited Partnership” or FLP has been developed through case law and has survived scrutiny from the IRS to become a legitimate estate and business planning vehicle.
What is an FLP?
An FLP is an estate planning device that allows the general partner to fund the device, transfer value to heirs, keep general control over the assets, and utilize various other strategies to reduce gift and estate taxes. In practice, an FLP is similar to a trust in so far as assets are transferred for the current and future benefit of others while allowing the grantor/general partner to keep control over the assets. The FLP differs from a trust in that it provides for tax and nontax advantages while offering potential unlimited life and can keep operating after the grantor’s/general partner’s death. While the trust still has a well established place in estate planning, the FLP’s niche in the business world is a little less established, but not devoid of its advantages.
The Limited Partnership (the LP portion of FLP) is a legitimate business entity under state statute. Legally, the General Partner is potentially liable for all the debts and claims against the entity to the extent of the business assets in the LP and personally held assets. The Limited Partners, on the other hand, are not subject to personal liability and are only liable for debts and claims to the extent of their investment in the FLP. The General Partner’s liability may be absolved by owning the general partner shares through an S Corporation or a Limited Liability Company.
How to Begin
An FLP is simply a Limited Partnership formed under state statute and owned by family members. One person (usually a parent) retains a 1% or 2% interest as the General Partner. The children are then granted up to a 98% interest, over time, as Limited Partners
The importance of the details of formation of the Limited Partnership should not be overlooked. While a typical partnership can be formed with no written agreement, the Limited Partnership REQUIRES that it be formed according to state statute. Beyond the formal creation requirements, case law has developed providing guidance regarding particularities in BOTH creation of the entity and in operation of the entity. One key ingredient being that the FLP have a valid, stated business purpose for its existence. If the particularities are overlooked, the IRS is free to scrutinize the FLP as a tax avoidance device and given the fierce history the IRS has had against FLPs, it is imperative that these particularities not be overlooked or disregarded.
The FLP will require that a professional business appraiser value the entity from time to time. There are discounts that can potentially be taken when the FLP is appraised. The first potential discount is the “control” discount. Since the limited partners have largely abbreviated rights to begin with AND lack of any element of control, their interest in the FLP is discounted to reflect the lack of control that they do not possess. The second discount that can be taken is one for lack of marketability. The simple fact is that interests in small, non publicly traded businesses lack overall marketability. An interest in a family owned limited partnership is equally as unmarketable. While discounts for lack of control and lack of marketability can be justified, extending and taking discounts without justification can be fatal to an otherwise well crafted valuation.
The FLP is one device/strategy of many that can be taken to plan for tax and business issues that your estate will face upon your death. The FLP is an extremely useful and tested device that can be applied in your estate and business planning. If you are interested in forming an FLP or would like more information, feel free to contact the professionals at The Center at (618) 997-3436.
By: Dr. Bart Basi at the Center for Financial, Legal and Tax Planning for Transworld M&A Advisors