A Family Limited Partnership (FLP) is the same as a traditional business limited partnership, except is structured to manage and hold assets of a family.
Reducing income and estate tax, transfer of ownership without losing control and liability protection are all potential benefits to setting up an FLP. Just as all limited partnerships, there are two parties involved: “General Partners” which control the partnership, and “Limited Partners” who have a share in the profits, but hold no control. It is important to structure an FLP, and operate the FLP correctly. If certain business procedures are not followed, the IRS or courts may rule that the FLP is invalid, thus negating the benefits which were the original motivation for setting it up.
Understanding the Two Types of Partners
The General Partners design the partnership to gift Limited Partner shares to family members. General Partners control the operations of the FLP and make day-to-day investment decisions. They can also receive a percentage of the FLP’s income in the form of a management fee.
Limited Partners have an ownership interest in the FLP, but they have very limited control. They share in the income generated by the FLP, depending on how many shares of the FLP they own. But, as far as control goes, they have almost no say. When the FLP is dissolved, a proportionate amount of FLP property will pass to each Limited Partner.
In the beginning, you and your spouse own both General Partner and Limited Partner shares. Over time, you may gift to your heirs Limited Partner shares using your annual $13,000 gift exclusion (2010) or use alternative estate planning techniques. Do not worry about giving away too many of the shares. Based on current tax law, the General Partners may own as little as 1% of the FLP’s assets and still retain control. That means you can still buy and sell assets, dispose of property, and declare any distributions on FLP shares.
Leverage Your Estate Tax Credit
FLPs potentially can allow you to pass more value than the maximum Estate Tax Exclusion amount (In 2009 $3.5 million or $7.0million per couple). For instance, a gift of Limited Partnership shares worth $2 million, in some cases, may be appraised at a substantially lower dollar amount. This is because the number of shares gifted lack significant control and therefore cannot be sold to others for full value. In other words, there is no “market” for Limited Partner shares. This lower appraisal is called “discounting” the value of Limited Partnership units. But be careful not to discount too heavily, as this could raise the attention of the IRS, and invalidate your FLP.
Because of their lack of control, Limited Partner shares are very undesirable to creditors. Creditors will find it difficult to seize Limited Partner shares, since they are not publicly traded.
Creditors also don’t want to pay tax on income they don’t receive. If the Partnership has earned income, but the General Partner does not declare a distribution, each General and Limited Partner is required to report a proportionate share of the earned income on his or her personal tax return, without actually receiving any dollars with which to pay the tax. This creates “phantom income” for the Limited Partners.
FLiPs Offer Other Advantages Too
Another important feature of FLPs is that they are considered an “intangible asset.” Thus, chances are that only the State in which in primarily reside will be able to impose any inheritance tax on Partnership units, as well as avoid probate in those States. This is ideal for real property owners that own property in several states.
Another Source of Retirement Income
FLPs, as mentioned before, can provide General Partners with a stream of income as a management fee. This fee reflects the work you do as the General Partner to maintain the FLP as a working business, and is considered earned income.
You may also draw income from your FLP through a Preferred Payment Provision. Such a provision could allow you to allocate a predetermined amount each year from the Partnership’s income. For instance, you could structure a FLP to pay you $50,000 per year for 10 years, for a total of $500,000. Just like the management fee, preferred payments are subject to income tax. Preferred payments reduce the value of the FLP, allowing you to possibly utilize other wealth transfer strategies.
Contact us at Financial Life Advisors for a complimentary consultation if your situation might benefit from a Family Limited Partnership.
This firm is not a CPA firm.
Financial Life Advisors (FLA), a Registered Investment Adviser, and Jim Oliver & Associates, P.C. (JOA) are under common ownership and control. Team Oliver is used to describe collaborative services of both firms. Professional tax services are provided by JOA and investment advisory services are provided by FLA, each under separate agreements.
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