Individuals with significant and varied assets (securities, real estate) who wish to reduce their taxable estate have been utilizing Family Limited Partnerships for many years. This wealth management strategy is an excellent way to remove a significant amount of assets from your estate while retaining control of those assets. Family Limited Partnerships can be flexible and provide a means to keep assets in the family.
Apex facilitates the creation of Family Limited Partnerships, successfully helping high net worth clients protect assets, transfer wealth and reduce estate taxes.
What is a Family Limited Partnership?
A Family Limited Partnership is an entity, like a corporation. It is used to protect assets and keep them in the family. A certificate is filed with state authorities to bring the Partnership into existence. The Partnership has a distinct identity and tax identification number. It can own assets and can conduct most activities that can be conducted by an individual or a regular corporation.
Who owns a Family Limited Partnership?
Partners own it. General Partners have a percentage of ownership and can generally control and manage the Partnership. They can make investment decisions and decide when and how much to distribute to Partners. A General Partner can be held responsible for any liabilities that the Partnership may have. Limited Partners have a percentage of ownership but have no voting or management participation rights. A Limited Partner should not have personal liability for any activities of the Partnership; much like a shareholder in a corporation is protected from any corporate liabilities.
What assets can be contributed into a Family Limited Partnership?
Family Limited Partnerships can be flexible and provide a means to keep assets in the family. These assets can include securities, real estate, private equity, privately held businesses, and other assets. The General Partner as well as the Limited Partners can contribute to the FLP.
A father would put assets such as his personal real estate investments and personal securities investments into a Family Limited Partnership and be the General Partner. He could then gift 50% of the Partnership to his children by giving them Limited Partnership interests. He would control the Partnership, but 50% of the assets, and all income and growth thereon, would be owned by his children.
Why is a Family Limited Partnership a preferred structure for intra-family gifting?
- Controlled Distributions: The General Partner can control the Partnership and its distributions. Income and profits from the Partnership do not have to be distributed; they can be reinvested.
- Restrictions: Limited Partners can be restricted from transferring, selling or otherwise “losing” their ownership interest.
- Valuation Discounts: A discount can be used in calculating the value of Limited Partnership interest given to family members. For example, a 10% interest in a $1,000,000 Limited Partnership may be valued substantially less than $100,000 for gift tax purposes due to minority interest and lack of marketability. Gifts of partnership interest also qualify for the $13,000 per year annual exclusion if structured properly.
- Creditor Protection: A certain degree of creditor protection is inherent in owning interest in a Limited Partnership. A Limited Partner’s creditors cannot directly levy upon Partnership assets and cannot “take a Limited Partner’s interest in the Partnership. Current law only allows for a charging order which requires that any monetary or financial distributions from the Partnership to a particular partner be given to that Partner’s creditors. The response to such an order can be that the Partnership simply reinvests earnings instead of making distributions
- Arbitration to Settle Disputes: A Family Limited Partnership Agreement can provide an arbitration provision to resolve any family disputes among Partners. The Partners simply agree in advance to have any disputes resolved by arbitration. The use of arbitration can avoid unwanted publicity or a possibly negative outcome in a jury trial that could otherwise be used to resolve disputes. There can also be a provision in the Partnership Agreement whereby a Limited Partner who brings an unsuccessful arbitration action against a General Partner would bear all of the costs of arbitration. This type of provision deters Limited Partners from bringing any frivolous or harassing actions against the General Partner.
- Buy-Sell and Right of First Refusal: A Partnership Agreement can include buy-sell and right of first refusal provisions to prevent unwanted persons from becoming Partners. A buy-out provision can provide that Partnership interests may be bought by other Partners or by the Partnership at fair market value or at a discount.
- Asset Protection in the Event of Divorce: In the event a Limited Partner has a failed marriage, the Family Limited Partnership can be structured to protect assets and keep them in the family. The Partnership can be used as a means to segregate the spouse’s property. Most courts are reluctant to award a Partnership interest to the other spouse in a divorce proceeding. In the event that the court does award a Partnership interest in a divorce proceeding, such event could trigger a buy-out provision which would enable the Partnership interest to remain in the family.
- Flexibility: Unlike an Irrevocable Trust, a Family Limited Partnership can be very flexible. A Family Limited Partnership may be amended or terminated if all of the members agree to do so.
- Reduced Costs: Placing all assets into a Family Limited Partnership can reduce administrative costs. There are fewer costs involved with placing all family assets in a single entity or trust than placing assets in several entities or trusts.
How can I benefit from “minority discounts” on gifts?
Family Limited Partnerships are an excellent gifting vehicle because children or beneficiaries can be given Limited Partnership interests that restricts their right to participate in management or financial decisions. The IRS has allowed minority discounts of up to 40% on Limited Partnership gifts due to their lack of control and marketability.
How is a Family Limited Partnership taxed?
A Family Limited Partnership is typically taxed like a regular partnership whereby all income and deductions flow to the Partners pro rata, based upon their Partnership interest. This can be altered by agreement, and certain tax laws may affect the income and deductions that flow through to each Partner.
The Partnership must file tax returns with the Federal government and distribute K-l’s to the individual Partners so that their share of the income and deductions of the Partnership can be shown on their individual 1040’s.
Unlike a regular corporation, there is no tax imposed on a Limited Partnership and, unlike an S Corporation, there is generally no tax when assets are conveyed from the entity to its partners. Limitations that apply to S Corporation ownership do not apply to Family Limited Partnerships.
What are possible complexities that should be addressed by my tax advisor?
Some of the complexities that must be addressed when establishing a Family Limited Partnership include making sure that the Partnership Agreement is carefully drafted so the Partnership is qualified as such under Federal tax law, and that income and expenses of the Partnership are properly allocated between the General and Limited Partners. The General Partner must also be adequately capitalized according to state creditor law and Federal tax law. The Federal tax law regulating partnerships can be significantly more complicated than other areas of Federal tax. It is definitely advantageous to use proper planning to avoid potential tax complications.
Is a Family Limited Partnership right for me?
If you own a significant amount of different types of assets (securities, real estate) and are looking for a way to keep those assets in your family while removing them from your estate subsequently minimizing estate taxes, than you should give serious consideration to this wealth transfer strategy.
As your trusted financial advisor, Apex works with estate planning attorneys to help create Family Limited Partnerships. Contact us today for further information.
The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax and/or legal advice regarding your individual situation from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.