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Family Limited Partnerships

A Family Limited Partnership (FLP) is an entity that can help preserve a family business for future generations while sheltering assets and reducing overall gift and estate taxes.  FLPs are commonly used as part of business succession planning, business continuity plans, and often serve as an integral component of an estate plan and asset protection vehicle for high net worth individuals.

An FLP is typically established by married couples who place assets in the FLP in exchange for limited partner interests, while the children place a nominal amount in and serve as general partners.  Subsequently, after a sufficient time period passes, the parents gift or sell limited partner interests to the children or to trusts for the children's benefit.  When this occurs, the assets are removed from the parents' estates, thus saving on future estate taxes.  The general partners control the FLP and its assets, even though they may own as little as 1% of the asset’s value.                      
                                   
Limited partners may receive distributions from the FLP, and enjoy certain tax benefits.  Asset protection is another attractive feature of the FLP. The FLP's assets are shielded from the limited partners’ creditors.  The interests in a FLP can be easily divided among family members, who may each own different amounts.  The FLP enables ownership of a business to transfer to the younger generation.
 
One of the significant benefits of a properly established and maintained FLP is that it can reduce the value of gifts to your children and grandchildren.  The value of each limited partner interest which you give away decreases the value of your taxable estate and, consequently, any estate tax due upon your death.   
 
Because limited partners do not have the ability to direct or control the day-to-day operation of the partnership, a minority discount can be applied to reduce the value of the limited partner interests that you are gifting.  Accordingly, the value of the partnership interests transferred to your beneficiaries may be far less than the corresponding value of the assets in the FLP. In addition, because the FLP is a closely-held entity and not publicly-traded, a discount can be applied based upon the lack of marketability of the limited partner interest.  This allows you to leverage the FLP as a vehicle to transfer more wealth to your beneficiaries.                   
 
With these significant tax benefits, it’s no surprise that FLPs have attracted scrutiny from the IRS.  Many have run into various problems due to mistakes or outright abuse.  Care must be taken to ensure your FLP is properly established and operated. Specifically, the IRS may look at the following issues when assessing the viability of the FLP:

  • It’s not all about taxes.  You stand a better chance of avoiding or surviving a challenge from the IRS if you can show a significant, legitimate non-tax-related reason (i.e., a real business purpose) the FLP was created.  Tax savings are an important consideration, but you must be able to demonstrate that there are other valid reasons, as well.
     
  • Keep your personal assets out of the FLP. You can reasonably expect to transfer closely held stock or interests in commercial real estate into a FLP.  However, personal property such as cars or residences will not fare well against an IRS challenge.  Similarly, the FLP’s assets should not be used to pay for any personal expenses, and you should retain sufficient assets and funds outside the FLP to cover your personal expenses for the expected duration of your life.  As noted, the FLP must be a legitimate business entity operated to fulfill a business purpose.
     
  • Have your FLP’s assets professionally appraised.  Partners or family members should not determine on their own the valuations or discounts for any assets transferred into the FLP.  A qualified appraiser has a much better chance of withstanding IRS scrutiny.
     
  • Don’t push it.  Many are tempted to put as many assets into the FLP as possible, to maximize the asset protection and tax savings benefits.  Unfortunately, if the FLP is successfully challenged, a significant portion of a partner’s net worth could be vulnerable to taxes or lawsuits.


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