How to Transfer Assets to Family Members and
Pay the Lowest Amount in Taxes.
Introducing the
Family Limited Partnership
What is a Family Limited Partnership?
The Family Limited Partnership (FLP) is a limited partnership created to transfer ownership of assets to family members with a minimum of tax consequences. The FLP is designed to lower the value of your investments and assets (for estate tax purposes) while still allowing you to maintain full control of your estate inside the limited partnership. It works particularly well to transfer a family business, real estate or an investment portfolio to the next generation. It helps to reduce estate taxes – and to reduce the risk that assets would need to be sold to pay those taxes. It may also help to shift income to family members in lower income tax brackets.
Here’s how it works: Senior members of a family convey a family business, investment portfolio or real estate to the Family Limited Partnership. Typically, the senior family members will own the limited partnership initially. In most cases, though not all, the senior family members will begin a gifting program to make gifts of partnership interests to younger family members. The senior family members retain control of the partnership. The FLP allows elder family members to introduce younger members to the family business and investments, while limiting their liability.
Two Types of Partners
In FLPs, two types of partners are involved: The General Partners, who control the partnership – and Limited Partners, who earn a share of the profit but cannot exercise control.
The general partner is usually an entity, such as a Corporation or a Limited Liability Company, owned by you and your spouse. Usually, though not always, you will gift partnership interests to the children. The general partners control the day-to-day operations of the FLP and make investment decisions. Also, they can receive a management fee based on a percentage of the FLP’s income.
Limited partners, which would usually be you, your children and maybe even grandchildren, own an interest in the FLP. They share part of the income from the FLP, calculated on the number of shares they own. But they have almost no control. When the heirs dissolve the FLP, the partnership’s property will pass to each limited partner based on their number of ownership shares.
6 Important Ways You Benefit
Discounted Value: By conveying income producing assets, such as rental property, into the FLP, the assets’ value can be discounted 25% or more. This is due to factors such as the lack of marketability of – or the minority interest in – the partnership shares. Gifting small interests in FLP assets during your life is an effective way to preserve a person’s $2,000,000 federal estate tax exclusion amount.
More specifically, the limited partnership shares can be discounted from the value of the underlying assets because (1) virtually no market exists for the shares, (2) the shares cannot be sold to someone else, (3) the limited partners have almost no control in the partnership, and (4) there may be no income from the FLP because the partnership pays the general partner for managing the business.
Limited Liability: In an FLP, the general partners can be personally liable for the acts of the partnership, but the limited partners are not subjected to such liability. Limited Partnership statutes are written to give the limited partners limited liability for partnership activities.
Estate Tax Exemption: FLPs often allow you to maximize the value of the federal estate tax credit ($2,000,000 per individual; $4,000,000 per couple.) to your heirs. This is because a gift of FLP assets may be appraised at a much lower figure than the assets held by the FLP. This means, due to discounting, you may be able to leave substantially more to your children, who still qualify to receive the inheritance free from estate taxes.
Income Shifting: By gifting interests in the FLP to family members, income that would otherwise be taxed at higher rate may be shifted to taxpayers in lower income tax brackets. Strict requirements govern income shifting. If these requirements are not met, the income may be reallocated by the IRS to the individual in the higher tax bracket. If the requirements are satisfied, tax savings of 25% to 35% may be realized.
Protection Against Creditors: If a partner is personally sued, the creditor cannot take his share of the partnership assets. Rather, the creditor is limited to a Charging Order. This remedy is of very limited benefit because (1) the creditor only has the right to receive distributions if and when distributions are made by the partnership, (2) the creditor can exert no control in the partnership, and (3) the creditor may be required to report income earned by the partnership even if the income is not distributed. This means the creditor may pay income tax on money it has not received. Creditors hate this, so creditors usually try to avoid Charging Orders.
Intangible Asset: FLPs are considered an intangible asset. This means the odds are good that only your state of residence will impose any inheritance tax on partnership interests. This is important for people who own real estate in several states.
In The Beginning . . .
. . . you and your spouse own shares as both general and limited partners. As time passes, you may gift your limited partner interests to your children and grandchildren, using your $12,000 per year gift exclusion. In some instances, gifts will not be made. However, this will not necessarily limit the effectiveness of the FLP. Substantial discounts will still be available. As majority owners of the general partner entity, you can give away 99% of the FLP limited partnership interests and still retain control, to the exclusion of limited partners.
Here’s How It Works
Example: John and Mary Jones own $5,000,000 in rental property or a closely held business. With conventional tax planning, they could shield only $4,000,000 from estate taxes after they die. This means they would face an estate tax of about $450,000, so their heirs would receive only about $4,550,000 of their $5,000,000 estate.
John and Mary can reduce their estate before they die by using lifetime gifts. Both John and Mary can gift $12,000 to each of their children every year, tax-free. If they have three children, they could give away $72,000 per year, lowering their estate’s value.
The Jones, however, also face the problem of increasing asset value. If their estate today is worth $5,000,000, their assets will probably increase in value faster than they gift it to their heirs. If their assets grow at the rate of 5% per year, in just 15 years their estate will double, increasing their estate tax. So even if they give away $72,000 per year, their estate will grow faster than they can give it away.
If John and Mary own real estate or a business, gifting to their heirs could pose problems. For example, making gifts in $72,000 increments is hard because few rentals or businesses are worth exactly $72,000. In addition, if the children own the real estate, they could face personal liability.
Now – if John and Mary set up a Family Limited Partnership, they could transfer their $5,000,000 business into the partnership with no tax consequences. Let’s assume there are 2,500 shares, so each share would represent $2,000 of the business value. Since the limited partners’ shares are discounted, the value of each share might be only $1,400. In this way, because of the discounted value, every year John and Mary could each give away seven shares to each child, rather than six. This will pass $14,000 of assets with no estate or gift tax liability.
This means if John and Mary each make the maximum tax-exempt gift to each of three children, they can gift $84,000 worth of assets each year, rather than only $72,000. What’s more, the children would benefit from protection against creditors and limited liability. And even if the parents have given the children 99% of the value in the business (or real estate), as general partners, they still retain complete control.
Further, when the parents pass away, the discounts should further reduce the size of the estate. For example, in John and Mary’s case, with a 30% discount, the $5,000,000 estate would be valued at $3,500,000. There would be no tax on this estate. That is an estate tax savings of $450,000.
Because of its many benefits, the Family Limited Partnership is one of the hottest tools in estate planning and asset protection. Parents can protect their assets from liability for a child’s car accident. They can shield their assets from lawsuits arising from renters and rental property. They can safeguard their assets from disputes that result from their business.
In today’s lawsuit happy world, NO business owner should be a sole proprietor because his assets are there for the taking. Every business owner must have a high level of asset protection, not only for his children, but also for himself and his spouse. And in the event the husband and wife ever divorce and remarry, the children’s assets are still protected.
I urge you to look at how a Family Limited Partnership will protect your assets – and help you transfer assets to your children and grandchildren, while paying the lowest amount in taxes.
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“If you have questions or concerns about asset protection, estate planning, probate, business planning or charitable giving, please don’t hesitate to call.
You’re welcome to contact me at any time, without cost or obligation.
I’ll be happy to help you in every way.” — Celeste
M. Celeste Luce
Asset Protection & Estate Planning Attorney