Did you know that there are estate planning tools your family can use to both protect your assets and potentially reduce your tax exposure? Known as an FLP, a Family Limited Partnership could be the answer to your estate planning questions.
When it comes to estate planning, business and property owners have advanced tools at their disposal. Schedule your complimentary consultation with a Wealth Enhancement advisor to learn more.
What is a Family Limited Partnership (FLP)?
A Family Limited Partnership (FLP) is a strategic estate planning tool that allows families to manage assets, protect their wealth, and potentially reduce overall tax burdens, all while facilitating the transfer of assets to future generations. Common use cases include preserving a family business or shielding assets from creditors. Whatever your goals are, an FLP could be a valuable part of your financial plan.
How does a Family Limited Partnership (FLP) work?
An FLP consists of two types of partners:
- General Partners (GPs) control day-to-day operations and make decisions about the assets.
- Limited Partners (LPs) own a stake in the FLP but have little to no authority—or liability.
One or more family members, typically parents or grandparents, establish the FLP and transfer assets into it. The GPs retain control, while LPs receive shares of ownership without direct responsibilities. As we’ll explain later, this allows the original asset holders to gradually shift wealth while maintaining authority over how assets are used.
Family Limited Partnership Example
To illustrate, let’s say two parents place a family-owned rental property into an FLP. They name an LLC where they are the only members as General Partners, and their children as Limited Partners. In this example, the parents would continue managing the property, collecting rent, and making decisions, such as renovations or upgrades. The children would have no responsibilities.
Over time, the parents can gift ownership shares to their children, gradually transferring wealth to them, while retaining full control over the property. Eventually, with proper planning, an adult child could become a General Partner, ensuring a smooth succession of management.
Who Should Consider a Family Limited Partnership?
An FLP is ideal for individuals and families who:
- Own businesses, real estate, or other significant assets.
- Want to minimize estate tax exposure.
- Want a structured way to transfer wealth while maintaining control.
- Need asset protection from potential creditors.
Next, let’s get into why FLPs are beneficial from a tax and asset protection standpoint.
What are the tax implications of using an FLP?
One of the key advantages of an FLP is its tax benefits:
- Gift tax. Ownership interests can be transferred to heirs at reduced tax rates using the annual gift tax exclusion.
- Estate tax. Assets placed in an FLP may qualify for valuation discounts, lowering the value of the family’s taxable estate and the value of gifts transferred to children.
- Asset transfer. When a General Partner dies, only their interest in the FLP is included in their estate, rather than the full value of the assets in the FLP. Thus, if the General Partners structure the FLP such that the Limited Partners own the vast majority of the partnership, they can greatly reduce the size of their taxable estate.
- Pass-through status. The IRS does not consider an FLP to be a taxable entity. Instead, partners report the income each year proportional to their ownership interest in the FLP. This means, with savvy tax planning, family members can allocate business income between family members.
Family Limited Partnership Discount Valuation Explained
The “Discount Valuation” aspect of an FLP is particularly notable. Because LP shares in an FLP are not easily sold on the open market and do not carry any decision-making power, they are accordingly worth less than a proportional share of the FLP’s total assets.
For instance, if the General Partner transfers 20% of an FLP’s shares to an LP, and the FLP holds assets worth $1 million, then those shares are nominally worth $200,000. However, because the transferred shares do not convey control, they may be valued 15% to 40% lower. This translates to direct gift tax savings.
While these benefits can allow for families to transfer assets at a lower tax rate, the IRS can scrutinize the valuation discount and dispute the depth of the discount. You will therefore want to work with an attorney and/or appraiser familiar with FLP structures to ensure an appropriate discount is claimed when a gift is given to hopefully withstand IRS scrutiny.
What are the legal protections provided by an FLP?
A Family Limited Partnership offers legal protections, particularly for Limited Partners. Here’s a rundown:
- Protection from creditors. Because Limited Partners don’t have control over FLP decisions, a creditor typically can’t seize or force the sale of a Limited Partner’s ownership stake.
- Personal liability protection. Limited Partners are generally shielded from personal liability for the FLP’s debts and other obligations, meaning their personal assets are off-limits if the partnership encounters financial issues.
Importantly, however, General Partners are liable for the FLP’s actions and obligations, meaning their assets aren’t protected in the same way. Because of this, many families establish separate LLCs to hold the General Partner interests in order to protect the parents’ personal assets.
How to set up a Family Limited Partnership (FLP)?
Setting up an FLP is not a straightforward task, as they require legal and administrative work at the front-end. To give you an idea of how the setup works, here’s an overview of the process:
- First, your attorney will establish the FLP by filing the correct documents with your jurisdiction (typically your state).
- Next, you will lay out the ownership structure in a detailed partnership agreement, designating both General and Limited Partners as well as distribution policies and responsibilities.
- Third, you transfer assets into the FLP, which usually involves obtaining a professional valuation of those assets.
- Last, the FLP will need to be run like a business. This means no comingling of personal assets with FLP assets, holding annual meetings with all members, and completing any necessary annual filings to maintain the business.
Ensuring legal compliance is paramount for your FLP. A Family Limited Partnership can convey both tax benefits and legal protections when set up and run correctly, so it’s crucial to get it right on the first attempt. This is why working with a comprehensive advising team is so valuable.
Is a Family Limited Partnership right for you?
An FLP can be a powerful estate planning tool when implemented effectively in the correct contexts. However, it’s not a one-size-fits-all solution. If you have a high-net-worth estate, a successful family business, or other high-value assets to protect, an FLP may help you pass on your legacy while minimizing your tax exposure.
Before establishing an FLP, consult with an estate planning attorney or financial advisor to determine whether it aligns with your overall goals. Wealth Enhancement offers complimentary introductory meetings for new clients—reach out today to schedule yours.
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