Proper estate planning helps business owners reduce estate and gift taxes, as well as manage the transfer of assets to heirs. However, one of the greatest challenges of estate planning is implementing a plan that will help you achieve your particular objectives. One estate planning technique that is often used for family business purposes is the family limited partnership (FLP).
A Closer Look
A partnership is created when two or more people join together for the purpose of a trade, business, or profession and share in the profits and losses. In a general partnership, every partner is presumed to be the authorized agent of the partnership and of all other partners for all purposes within the scope and objectives of the business. As a result, all partners have unlimited liability.
A limited partnership consists of two or more persons with one or more general partners and one or more limited partners. A limited partner has no right to participate in the management and operation of the partnership business or to interfere in any manner with its conduct or control. There is no liability for the limited partner in regard to the business beyond his or her capital allocation. A family limited partnership is an entity formed as a statutory limited liability partnership under state law in which the only partners are family members.
In a typical case, parents establish a family limited partnership by transferring investment assets to it. Investment assets can include real estate or stock investments such as the family farm or stock in the family business, assuming the business is a C corporation. Parents can also contribute appreciating property directly to their children and then form a partnership, or simply gift partnership interest in their business to their children directly, after contributing property to the partnership.
In most cases, the parents will retain the general partnership interest because the general partner controls, manages, and operates the partnership. Initially, they will probably own the greatest percentage of the limited partnership interests with the children receiving a small, limited partnership interest that may be enough to utilize the annual federal gift tax exclusion. Over time, the parents usually give most of the limited partnership interests to their children.
Gifts of limited partnership interests can generate substantial discounts for lack of marketability and minority interests. After the FLP has been valued in accordance with normal valuation principles, the value of a partner’s interest will be adjusted for various factors including control, minority interest, lack of marketability, or restrictions in buy-sell or other agreements. The Internal Revenue Service (IRS) has acquiesced to favorable Tax Court decisions that permit discounts even when the gifts are made among family members. These discounts can range from 20% to 40%. The use of these discounts allows the parents to give more than they would otherwise be entitled to give if the gift was cash or a marketable security.
One important advantage to the FLP as an estate planning tool is that it allows the general partner, who is also a limited partner, to give his or her limited partnership interest away and still retain control over the entity. This control over the limited partnership is to be exercised as a fiduciary and, therefore, will not pull gifted interests back into the estate. However, as general partners, the parents are entitled to receive payment for their work.
Over time, FLPs have become a more common estate planning technique. If you determine that this technique is right for your particular situation, you may be able to utilize some of its estate and gift tax advantages. However, only proper planning by your financial, legal, and tax professionals will help ensure the best possible result for both you and your family.