WHAT IS A FAMILY LIMITED PARTNERSHIP?

A family limited partnership (FLP) is a limited partnership in which all the partners are family members or entities created by or owned by family members. A limited partnership is a common business entity that consists of at least one general partner and at least one limited partner. A general partner, who can own as little as one percent of the partnership interests, has the entire right to manage the business and can be held personally liable for partnership debts. A limited partner has no right to participate in managing the partnership business and has limited liability for partnership debts.

WHO ARE THE GENERAL PARTNERS OF AN FLP?

The general partners are almost always parents or grandparents, or corporations, limited liability companies, or management trusts controlled by those individuals.

WHY WOULD ANYONE WANT TO CREATE A CORPORATION, LIMITED LIABILITY COMPANY OR MANAGEMENT TRUST TO BE AN FLP GENERAL PARTNER?

By law, a limited partnership dissolves upon the death or disability of its general partner. Using these entities provides continuity within the partnership if such an event occurs. They are also used to create an additional layer of protection from the claims of aggressive judgment creditors. Using a corporation as a general partner also provides income tax planning options. The corporation may charge fees and receive income for management of and duties performed for the FLP. This shifts some of the income from the limited partnership to the corporate general partner. The corporation can then use the income to pay salaries or set up retirement and other tax-advantaged plans such as welfare benefit trusts, defined-benefit plans, and medical reimbursement plans. As a result, the family is able to shift income from higher to lower income tax brackets and, at the same time, set up retirement pension plans for family members who are employees of the corporate general partner.

WHO ARE THE LIMITED PARTNERS?

The limited partners are often children and grandchildren of the general partners, irrevocable trusts created by the senior family members for the benefit of junior family members, or revocable living trusts created by senior family members as part of their own estate planning.

WHAT ASSETS CAN AND CANNOT BE CONTRIBUTED TO AN FLP?

Other than personal-use assets, such as a personal residence, most investments assets can be put into an FLP. Even family businesses can be contributed to an FLP. Closely held corporate stock of a family corporation can also be put into the partnership. The following types of assets generally should not be used to fund FLPs:

• Stocks

HOW CAN I CAN USE AN FLP FOR GIVING PROPERTY TO MY CHILDREN?

Typically, you, the parent, will be the general partner, and you will also be the initial limited partner. You will then make gifts of limited partnership interests to your children. There are several advantages to making gifts of limited partnership interests: The general partner retains complete control over the business even if the children hold all the limited partnership interests. The general partner can receive partnership income as payment for management services and as a "special allocation” of partnership income. The limited partnership interests are valued at a discount, usually at least 25 percent, from their pro rata share of the assets inside the partnership. The FLP offers asset protection for the individual partners.

WHO APPRAISES THE PARTNERSHIP INTERESTS FOR PURPOSES OF THE DISCOUNT?

A qualified appraiser must appraise the value of the partnership assets and then the value of the limited partnership interests in terms of restrictions under state law and in the partnership agreement. These appraisals, while related, are not the same. The former involves the value of the assets held in the FLP, and the latter involves the value of the ownership interests in the FLP as an entity.

IS THE IRS LIKELY TO CHALLENGE AN FLP?

The IRS does not like family limited partnerships when used to obtain large discounts in the value of an estate, thereby saving estate and gift taxes that would otherwise be due. The IRS admits that valuation discounts of FLPs are legitimate, but it still challenges them in many situations. A challenge is most likely if the FLP is created just before death. Forming an FLP two days before death or when the parent is incapacitated invites the IRS to attack the partnership as solely a scheme for avoiding tax.

MIGHT THE LAWS WHICH FAVOR FLPs CHANGE IN THE FUTURE?

Since the IRS does not like the substantial estate and gift tax savings realized through the use of FLPs, it is possible that legislation in the future could limit the estate tax savings. However, you must remember that there are many advantages to the FLP, and it is unlikely that all the advantages will be taken away in one fell swoop. For instance, the creditor protection afforded by FLPs is created by state law and cannot be easily affected by federal law changes. Also, the ability to give shares of the partnership to children and relatives without giving up control of the assets within would survive any change in the law on valuation of partnerships for gift tax purposes.