As an estate planning tool, the family limited partnership (FLP) can play a valuable role in the estate planning process. However, it comes with additional costs and disadvantages. It's important to properly assess whether using an FLP is appropriate for your specific needs and, if so, to retain expert assistance to structure and maintain the FLP so that it is effective.
How does a family limited partnership work?
An FLP is a specific type of limited partnership that involves two types of partners:
- General partners. Typically, general partners of an FLP are more senior family members—parents or grandparents—who have accumulated a certain level of wealth. They retain full control over assets they have transferred into the FLP, but the general nature of their partnership share also means that they have unlimited liability.
- Limited partners. In an FLP, limited partners are usually made up of younger family members, such as children and grandchildren. Unlike general partners, the limited partners have no say in the partnership's operation, but they do have, to a certain extent, the protection of limited liability.
How to set up a family limited partnership
In a typical FLP, parents transfer assets to the partnership in exchange for general and limited partnership shares. They retain their general partnership shares, and may also have some limited partnership shares. The remaining limited partnership shares are distributed among their children and grandchildren, who then become limited partners.
While the FLP is most typically used as an estate planning vehicle, it's important to note that it must be run like a limited partnership to maintain its validity as an FLP.
Family limited partnership advantages
FLPs have a number of advantages within the context of a comprehensive estate plan. These benefits include:
- Asset protection. Because the FLP is a separate legal entity, once assets are properly transferred to an FLP's ownership, those assets become the property of the FLP. This effectively places these assets outside the reach of any future or potential creditors of the individuals (general partners) who owned the assets prior to their transfer to the FLP. The partnership agreement can ensure that if a limited partner ceases to be a family member—for example, in the context of a divorce—their shares must be transferred back to the FLP, usually at fair market value. This has the effect of keeping assets within the family structure.
- Control and flexibility. As a limited partnership, an FLP is run in accordance with its partnership agreement. This means that general partners retain control over the FLP's assets. And because the partnership agreement is open to amendment, the FLP retains a certain measure of flexibility for its general partners.
- Estate tax reduction. Transferring assets to an FLP removes them from the general partners' estates, which effectively reduces their estates' size and lowers the estate tax burden.
- Wealth distribution. The FLP allows individuals to distribute their wealth to heirs through limited partnership shares. The value of such shares is less than that of the assets held by the FLP because their appraised value is discounted due to factors such as their limited marketability.
- Gift tax reduction. Once assets are transferred to the FLP, the general partners can take advantage of the annual gift tax exclusion to implement a gradual transfer of the FLP's interests to their children and grandchildren. So long as the value of the limited partnership shares falls under the annual gift tax exclusion threshold, the distributions will not be subject to gift taxes.
- Income tax reduction. As a limited partnership, the FLP is taxed on a “pass-through" basis. This means the FLP is not subject to taxes itself. Instead, its income and losses are passed on to the general and limited partners in proportions equal to their interest in the FLP. Thus, the FLP takes advantage of the typically lower tax brackets of its limited partners. For example, a child who is attending college will likely be in a lower tax bracket than their parents and will pay a lower income tax.
Family limited partnership disadvantages
While the FLP offers many advantages, certain disadvantages may make it unsuitable for your estate planning needs:
- Complexity. Because of the complexities in structuring the FLP, it's often necessary to retain the services of experienced professionals. This isn't limited to an estate planning attorney with experience in FLPs. Other professionals who may need to establish and maintain the FLP include tax experts and appraisers.
- It's a business. The FLP remains, at its core, a business, and a number of important issues arise from this. Because the FLP is a business, it may not be the proper vehicle for ownership of personal assets. And in order to maintain its validity as an FLP, the FLP must be run conscientiously, like you would run a business.
- Costs. Retaining the various professional services required to establish and run the FLP and maintain its validity can be expensive. You may find the total costs prohibitive compared with the FLP's estate planning advantages.
To determine whether the FLP is the right vehicle for your estate planning needs, consult with legal and tax experts with experience in structuring FLPs.
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