A family limited partnership (FLP) can be a great estate planning tool for families looking to transfer wealth, minimize their estate tax liability, and ensure asset protection. However, like with other estate planning tools, FLPs have their advantages and disadvantages, and it’s important that you understand them before deciding whether or not one is right for you.
In this article, you’ll learn about the pros and cons of using an FLP as part of your estate plan. You’ll also be exposed to how FLPs work and be given answers to commonly asked questions about the tool. Finally, you’ll see how to set up an FLP yourself, and where you can go for further help in leveraging the benefits it offers.
What is a Family Limited Partnership?
A family limited partnership (FLP) is a legal structure in business that allows family members to pool their assets and invest together. With an FLP, family members can contribute assets like cash, properties, or stocks to the partnership. However, management and decision-making power over the assets is split between the “general partners” and the “limited partners.”
General partners (usually parents) have power over the investment decisions of the partnership. They’re also the ones who oversee the FLP’s day-to-day activities. Limited partners (usually children or grandchildren) play a more passive role and do not participate in any formal management.
There are several reasons families chose to use FLPs in estate planning. A major reason is for tax savings purposes. Because FLPs are a partnership, they’re not subject to income tax at the partnership level. Instead, the profits and losses pass through to each of the partners’ individual tax returns, where they’re taxed at the individual level.
Furthermore, you’re also able to reduce your gift and estate tax liability using an FLP. By gifting partial ownership of your assets to limited partners, you’re able to reduce your taxable estate and reduce your gift tax liability. That’s because your limited partners hold partial ownership of the assets in your FLP, which are valued at a discount for gift and estate tax purposes.
Another reason families choose to use FLPs is that it allows certain family members (again, usually the parents) to transfer wealth to the next generation, without having to give up control of their family’s assets. By gifting limited partnership interests to other family members like their children or grandchildren, assets can be passed on at a discounted value thus reducing gift taxes if the amount is not covered by your lifetime gift and estate tax exclusion. Additionally, while assets are inside an FLP, they can be protected from creditors, lawsuits, and irresponsible family members. Fa
Advantages of a Family Limited Partnership
Tax Savings: You’re able to discount the amount you use to fund your FLP because the worth of such assets is lessened by the limited partners’ minority interest. As a result, you can use a smaller percentage of your gift and estate tax exclusions when funding the partnership. Additionally, profits and losses are taxed at the individual level on each partner’s personal tax return.
Asset Protection: Assets placed inside an FLP can be protected from the likes of creditors, lawsuits, and irresponsible members of your family.
Control: The general partners of an FLP maintain control over the partnership, which allows you to make management decisions on how your family’s assets are to be preserved.
Succession Planning: An FLP can be a valuable tool for succession planning as well. It can be used to educate future generations on how to take over the family business. It can also facilitate a smooth transition of wealth and decision-making authority to the next generation.
Customizable: FLPs can be customized to meet the specific needs of your family and estate. You can vary the ownership interests of partners and assets inside it.
Disadvantages of a Family Limited Partnership
Complexity: Family limited partnerships are known for their complexity from both a legal and business standpoint. Should you pursue this option, you need to prepare yourself for the more rigorous setup process, maintenance, and legal regulations that are involved.
Cost: Given their complexity, family limited partnerships are also costly to maintain. Depending on the size of your business, it may be advisable to keep professionals like estate planning attorneys, CPAs, and property valuation experts on your payroll.
Family Disputes: Decision-making power resides with the general partners of an FLP. As a result, limited partners (i.e. other family members) can become argumentative over decisions made beyond their control.
Lack of Flexibility: FLPs can be difficult to modify or terminate. Additionally, liquidity issues can arise for limited partners given the potential hurdles they must overcome to sell or transfer interests in the partnership.
High Scrutiny: FLPs in particular can be abused in estate and gift tax planning. For this reason, the IRS places higher scrutiny on the tool.
Family Limited Partnership FAQs
Family Limited Partnership Taxation Rules?
A family limited partnership (FLP) is what’s known as a pass-through entity. No taxes are paid by the partnership itself. Rather, profits and losses are “passed through” to general and limited partners based on the percentages they own. All necessary tax information is then reported on each partner’s personal tax return.
Family Limited Partnership vs Trust: What’s the Difference?
Both a family limited partnership (FLP) and a trust can be used to transfer wealth to beneficiaries in a tax-efficient manner. However, they differ in their overall structure and purpose. An FLP is a business arrangement where ownership of assets is divided into shares, but control is maintained by certain parties (general partners). This arrangement allows families to grow wealth together.
A trust, on the other hand, is a fiduciary arrangement where assets are held by a third party for the benefit of the trust creator’s beneficiaries. Trusts come in a multitude of varieties and are used for several functions that extend well past those of just a family business. Whether or not you should use a trust or an FLP (or both) will depend on your unique situation.
Family Limited Partnership vs LLC: Which Is Right For You?
There are some important differences between a family limited partnership (FLP) and a limited liability corporation (LLC). With FLPs, ownership is split between general partners and limited partners, but only the general partners have decision-making authority. LLCs, however, enable anyone to have decision-making power.
Additionally, LLCs protect all parties involved from liability, whereas FLPs only offer limited partners such protection. However, FLPs have a tradeoff of a special tax benefit when ownership is gifted as inheritance over generations. Ultimately, the business structure you should choose comes down to your particular situation. If you’re specifically aiming to keep, grow, and transfer wealth through a family-run business, then an FLP may be a better course of action.
What Happens when the Family Limited Partnership’s General Partner Dies?
What happens to an FLP when a general partner dies will depend on the instructions laid out in the partnership agreement. In some cases, it could result in the dissolution of the FLP if there are no more general partners to oversee the partnership. In other cases, a new general partner may be appointed to oversee the continuation of the existing partnership.
How to Get Out of a Family Limited Partnership?
Exiting an FLP can be as complicated as setting one up. The process will depend on the terms of the partnership agreement. In some cases, a partner may choose to sell their stake in the FLP to another qualifying party. In other cases, the partnership agreement may spell out a specific buyout process, or partners will have to negotiate an exit agreement of their own.
How to Set Up a Family Limited Partnership
Family limited partnerships are known for their complexity. They require careful planning and strict adherence to various legal and tax requirements. Below, you’ll see a step-by-step guide that can walk you through the process:
Step 1) Have Clear Criteria: Before establishing a family limited partnership (FLP), you’ll want to determine the specific goals of your partnership. What assets are you looking to transfer? Who are your general and limited partners going to be? What percentage will each of your partner’s own in the FLP?
Step 2) Hire an Estate Planning Attorney: FLPs are complex. You’ll want to work with an experienced attorney who can navigate you through everything. Your attorney will help with drafting the appropriate legal documents and maintaining compliance with relevant federal and state regulations.
Step 3) Draft Your Partnership Agreement: Your family limited partnership agreement is the legal paperwork that dictates the terms and conditions of your FLP. It includes the roles and responsibilities of the partners, the management structure of the FLP, and how profits and losses are distributed.
Step 4) Fund Your FLP: You’re able to fund your FLP with a variety of assets. They can include properties, securities, and other investments. The general partners fund the FLP initially, then the limited partners receive percentage-based ownership stakes.
Step 5) Get an Employer Identification Number (EIN): Your FLP needs an EIN from the IRS to maintain compliance with tax regulations.
Step 6) File Required Documents: To legitimize your FLP, you’ll also need to file the correct paperwork (ex: articles of incorporation). Please note, the documents you’re required to file can vary by the state you’re operating in.
Step 7) Continue to Comply With Regulations: FLPs must continue to be monitored over time. Ongoing meetings, recordkeeping, and routine tax filings are necessary to make sure your FLP continues to maintain compliance with the appropriate regulations.
How CW O’Conner Can Help You Further
At CW O’Conner it’s a privilege to help our clients keep their legacies intact. And the primary way we’re able to help is by ensuring you have the right estate plan in place.
Depending on your unique family situation, it may be worth looking into a family limited partnership. They’re a powerful tool that enables you to control your assets, look after future generations of your family, and continue to build your family’s wealth.
As a team, we’ll help you navigate the complexities of putting an FLP into place. We’re able to work with your attorney and tax professional or recommend ones of our own. Our vetted network of industry professionals can point you in the right direction for all your estate planning needs.
If you’re ready to establish an FLP, or have further questions on whether or not one may be right for you, please don’t hesitate to reach out. You can call us directly at 770-368-9919, or fill out a contact card, and we’ll reach out to you.
The opinions and analysis expressed herein are based on C.W. O’Conner Wealth Advisors, Inc. research and professional experience and are expressed as of the date of this report. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice.
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Cliff is the founder and president of C.W. O'Conner Wealth Advisors, Inc. Cliff earned a Bachelor of Business Administration degree in Accounting from Georgia State University.
Kevin O'Conner is a financial planner with C.W. O'Conner Wealth Advisors, Inc. He earned a Bachelor of Business Administration degree in Business Management from Georgia College, and is a Certified Investment Management Analyst (CIMA).
