Frequently Asked Questions
Family Limited Partnerships
Someone told me I should set up a family limited partnership. How does that work? Family limited partnerships (FLPs) can help families keep business assets together and working, even in times of transition such as death or retirement. They are not for everyone and every situation, however.
What is an FLP? A limited partnership is a type of business organization recognized in Texas and most states where the management rights and responsibilities are vested in one or more general partners while most of the ownership interests are vested in limited partners. A limited partnership is a flow-through entity for income tax purposes, meaning that the partners pay income taxes or enjoy tax benefits individually, based upon their ownership interest in the partnership. A family limited partnership is not a different type of business organization. Rather, it is often used to describe a limited partnership where most or all of the general partners and limited partners are related to each other.
Who typically sets up an FLP? Families with business assets which they wish to own in common including assets which some family members wish to pass on to other family members may benefit from an FLP. For example, parents owning all or most of the interest in a restaurant who wish to involve their children in ownership and management of the business may benefit from setting up an FLP. The FLP permits the family to have flexibility in dividing ownership and control in ways which work for its members. Because the organizational costs can be substantial, families with business assets of less than $2 million rarely find it advantageous to establish an FLP.
What type of assets work in an FLP? Any type of business or investment assets can work in an FLP. Assets connected with an operating business, such as a store or ranch, work particularly well, but some families establish FLPs solely with investment-type assets. Personal assets, such as homes and furniture, should not be placed in an FLP. Also, retirement accounts, such as IRAs and 401k plans, usually dont work in an FLP.
What are some of the benefits of an FLP? Among the benefits are: (1) Centralization of Management An FLP permits ownership to be fractionalized while management remains centralized. (2) Facilitating Intra-Family Transfers FLPs can make it easier to transfer interests in family business assets from one family member to another. For example, a parent can transfer a specified percentage of a collection of business assets (in other words, an interest in the FLP) to each child, rather than multiple transfers of specific assets. (3) Discounts -- In many cases, the FLP interests owned or transferred by a family member are valued at less than the underlying assets would be valued if the partnership did not exist, potentially saving transfer taxes. (4) Avoiding and resolving family disputes FLPS can provide a means to resolve existing a future family disputes and make it more likely to avoid these disputes entirely.
Ive heard about FLP discounts. How does that work? Assets are valued for gift and estate tax purposes at their fair market value what a willing buyer would pay a willing seller for those assets. FLPs typically have restrictions on their transferability. For example, transfers to non-family members may be prohibited unless other family members agree. Also, there may be a smaller number of persons interested in buying limited partnership interests than there would be for the underlying assets. These factors restrictions on transferability and lack of marketability, among others can make the price a willing buyer would pay for an FLP interest less than what the same type of buyer would pay for the underlying assets. This difference the discount can reduce the amount of gift and estate taxes payable. Discounts can range from nothing to 50% or more, depending upon many factors, including the terms of the partnership agreement, the type of partnership assets, the ownership percentages of the various partnership and how the partnership is operated. The Internal Revenue Service does not like that FLPs often receive discounts for estate and gift tax purposes, and it has several ways to attack discounts. Because of this, no family should assume that discounts will be available for their FLP. There should be reasons other than possible discounts for creating the FLP.
What are some of the drawbacks of FLPs? Among the drawbacks are: (1) Organizational costs -- Setting up an FLP typically costs $5,000 or more, so the potential advantages need to outweigh this upfront cost. (2) Operating requirements The FLP must be operated as a separate business, with separate bank and investment accounts and separate tax returns (the tax effects flow through to the partners, but a separate tax return is required). The FLP form must be respected, which will mean changes from prior family practices. Personal finances and partnership finances must be kept separate. Many persons arent willing to make these changes, and FLPs are not for these people. (3) Tax scrutiny The IRS scrutinizes FLPs for estate and gift tax purposes because it does not like the discounts many FLPs receive. Families should be prepared for this type of scrutiny when gift and estate tax returns are filed.
Family limited partnerships are not a panacea, but they can be the right estate planning tool for many families. Contact The Karisch Law Firm, PLLC for more information..