Many people want to enrich their children and grandchildren with their wealth, possessions and business interests. The problems in the past have been the inability to control the assets once they were given and the potential of facing estate tax issues when assets are substantially appreciated.
The device, known as “The Family Limited Partnership,” or FLP, has been developed through case law and has survived scrutiny from the IRS to become a legitimate estate and business-planning vehicle.
What is an FLP?
An FLP is an estate planning device that allows the general partner to fund the device, transfer value to heirs, keep general control over the assets and utilize various other strategies to reduce gift and estate taxes. In practice, an FLP is similar to a trust insofar as assets are transferred for the current and future benefit of others while simultaneously allowing the grantor/general partner to keep control over the assets. The FLP differs from a trust in that it provides for tax and nontax advantages while offering potential unlimited life and it can keep operating after the grantor’s/general partner’s death. While the trust still has a well-established place in estate planning, the FLP’s niche is a little less established but not devoid of its advantages.
The Limited Partnership (the LP portion of FLP) is a legitimate business entity under state statute. Legally, the General Partner is potentially liable for all debts and claims against the entity to the extent of the business assets in the LP and personally held assets. The Limited Partners, on the other hand, are not subject to personal liability and are only liable for debts and claims to the extent of their investment in the FLP. The General Partner’s liability may be absolved by owning the general partner shares through an S Corporation or a Limited Liability Company.
How to Begin
An FLP is simply a Limited Partnership formed under state statute and owned by family members. One person (usually a parent) retains a one-percent or two-percent interest as the General Partner. The children are then granted up to a 98-percent interest, over time, as Limited Partners.
The importance of the details of formation of a Limited Partnership should not be overlooked. While a typical partnership can be formed with no written agreement, the Limited Partnership requires that it be formed according to state statute. Beyond the formal creation requirements, case law has developed providing guidance regarding particularities in both creation of the entity and in operation of the entity. One key caveat is that the FLP have a valid, stated business purpose for its existence. If the particularities are overlooked, the IRS is free to scrutinize the FLP as a tax-avoidance device, and given the fierce history the IRS has had against FLPs, it is imperative that these particularities not be overlooked or disregarded.
The FLP will require that a professional business appraiser value the entity from time to time. There are discounts that can potentially be taken when the FLP is appraised. The first potential discount is the “control” discount. Since the limited partners have largely abbreviated rights to begin with and lack any element of control, their interest in the FLP is discounted to reflect the lack of control that they do not possess. The second discount that can be taken is one for lack of marketability. The simple fact is that interests in small, non-publicly traded businesses lack overall marketability. An interest in a family-owned limited partnership is equally as unmarketable. While discounts for lack of control and lack of marketability can be justified, extending and taking discounts without justification can be fatal to an otherwise well-crafted valuation.
The FLP is one device/strategy of many that can be used to plan for tax and business issues that your estate will face upon your death.
Dr. Bart A. Basi is an expert on closely held companies, an attorney, CPA and senior advisor for the Center for Financial, Legal & Tax Planning, Inc. He can be reached at (618) 997-3436. This article is reprinted by permission.