A Family Limited Partnership (FLP) can be a great way to use estate and income tax planning to preserve wealth for your children, as well as a good tool for business succession planning.
An FLP is a formal partnership among family members, including ancestors, lineal descendants, spouses, and trusts. The FLP may be used to hold closely held stock, real estate, life insurance, and other income-producing property. Typically parents create an FLP and contribute assets to it in exchange for ownership interests, which include a small general partnership interest and a large limited partnership interest. Initially the parents own both a general and limited partnership interest. The parents can then gift the limited partnership interests to their children or to trusts for the benefit of their children using their annual gift exclusion and unified credit.
The parents retain the general partnership interest, which allows them to manage and control the FLP’s assets, while still affording a benefit to their children. The partnership agreement also can ensure the family’s interests by including a clause that requires the sale of any partnership interest to be offered first to family members to prevent non-family members from acquiring an interest in the partnership.
In addition to retaining control of the assets, parents gain additional benefits. The gift of a limited partnership interest to the children can be discounted because they lack control and marketability of their interests. This discount allows the parents to generally gift a larger value than if the assets had been held outside of the family partnership. The gifted value as well as any future appreciation on those assets is removed from the parent’s estate. Since the goal is to get as much of the limited partnership interest to the children, most of the income earned in the partnership would pass to the children who, depending on their age, may be in a lower income tax rate than their parents.
Family limited partnerships also can pose some challenges. These include expenses for the formation of the partnership, annual cost of preparation and filing of partnership returns, and valuations of the gifts. Also, there has been increased IRS scrutiny and other potential pitfalls may occur if it is not structured and maintained properly.
Creating and using an FLP involves many rules, but it can be a good planning tool to achieve your estate and income tax planning objectives.
Allison J. Shoemaker can be reached at Email or 215.441.4600.