Features of Family Limited Partnerships

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.





Gift and Estate Tax Issues of FLPs

HOW CAN I 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.




WHAT IF WE ARE SETTING UP A FAMILY LIMITED PARTNERSHIP ONLY TO REDUCE OUR ESTATE TAXES - WON'T THE IRS SEE THROUGH IT?


It does not matter if the principle reason for establishing an FLP is to reduce tax liability, as long as there exists a business, investment, or financial reason for using that type of entity. Courts have made a determination that the IRS cannot disregard the existence of a partnership if the partnership is formed for business, investment, or financial reasons.




WHAT ARE SOME OF THE REASONS I CAN SET FORTH IN MY PARTNERSHIP AGREEMENT TO SATISFY THE BUSINESS-PURPOSE REQUIREMENT FOR MY FLP?


Your partnership will need to have a purpose such as:

  • Managing and/or developing real estate and other assets
  • Protecting partnership assets from the claims of creditors
  • Providing a reasonable and smooth economic arrangement among the members of your family to maintain the partnership assets in the family
  • Ensuring family harmony by providing that any dispute will be resolved by arbitration rather than going through the court system
  • Preventing assets of the family from being taken through the probate court system on the death of a family member
  • Providing for smooth succession and control of your family’s assets
  • Consolidating family assets which are held in fractional interests
  • Creating an orderly and consolidated management system for all assets held by the partnership





Funding an FLP

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
  • Annuities
  • IRC section 1244 stock
  • Professional corporation or association stock
  • Potential liability-producing assets
  • Assets with debt in excess of adjusted basis
  • Personal-use assets
IRAs and other qualified retirement plan assets, as well as S corporation stock, should never be contributed to a partnership of any kind.





Valuation of Partnership Interests

HOW CAN I 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.




WHAT IF WE ARE SETTING UP A FAMILY LIMITED PARTNERSHIP ONLY TO REDUCE OUR ESTATE TAXES - WON'T THE IRS SEE THROUGH IT?


It does not matter if the principle reason for establishing an FLP is to reduce tax liability, as long as there exists a business, investment, or financial reason for using that type of entity. Courts have made a determination that the IRS cannot disregard the existence of a partnership if the partnership is formed for business, investment, or financial reasons.




WHAT ARE SOME OF THE REASONS I CAN SET FORTH IN MY PARTNERSHIP AGREEMENT TO SATISFY THE BUSINESS-PURPOSE REQUIREMENT FOR MY FLP?


Your partnership will need to have a purpose such as:

  • Managing and/or developing real estate and other assets
  • Protecting partnership assets from the claims of creditors
  • Providing a reasonable and smooth economic arrangement among the members of your family to maintain the partnership assets in the family
  • Ensuring family harmony by providing that any dispute will be resolved by arbitration rather than going through the court system
  • Preventing assets of the family from being taken through the probate court system on the death of a family member
  • Providing for smooth succession and control of your family’s assets
  • Consolidating family assets which are held in fractional interests
  • Creating an orderly and consolidated management system for all assets held by the partnership





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