Family Limited Partnerships: Effective Estate Tax Trimmer
posted Aug 5, 2016 by Dave Desmarais, CPA/PFS, MST, MBA, AEP® in the Global Tax Blog
Establishing a Family Limited Partnership (FLP) can be extremely beneficial for you and your family when figuring out how to handle money, property and other family investments. For families with substantial real estate holdings, this method of estate planning is especially useful. If you’re looking to save thousands of dollars in gift and estate taxes, learn how to effectively set up a FLP.
Breakdown of a FLP
A Family Limited Partnership (FLP) is a limited partnership (offers some members limited liability for business debts) controlled by members of a family. The partnership:
- Consists of two types of partners:
- General- Directs and oversees all management and investment decisions and bears 100% of the liability.
- Limited- Are not permitted to participate in the FLP’s management; have limited liability.
- Is not taxable; rather the owners of the FLP report its income and deductions on their personal tax return, in proportion to their interests.
- Is generally contributed to primarily by the senior family members (parents/grandparents). In exchange for their asset contributions, these family members typically receive a small general partner interest and a large limited partner interest.
- Allows senior family members to give some or all of the limited partner interest to their heirs (children, grandchildren, etc.) This can be set aside in a trust, too.
How do FLPs help with estate plans?
There are a number of benefits to FLPs, namely:
- Reduces the taxable estate of senior family members by transferring limited partnership interests to other family members;
- Allows senior family members to maintain control over the investment decisions and distributions
- Valuation discounts for lack of control, liquidity, and minority interests take some of the burden off their federal estate tax obligations.
- Limited partnership interest transfers qualify for the annual gift tax exclusion. Check out our blog, “IRS Updates Estate and Gift Tax Limits for 2016” for more information on the gift tax exclusion.
- FLPs are cheaper to set up than an LLC (limited liability company) or a corporation.
Is it hard to set up an FLP?
Getting started with establishing a family limited partnership is fairly simple. Steps are as follows:
You must draw up a written limited partnership agreement to begin the process. What should you include?
- Date of agreement
- All names of those involved in partnership
- Purpose and length of the FLP
- Contribution information for each member of the partnership
- Duties/compensation of general partner
- Duties/compensation of limited partner(s)
- Information on who takes over/what happens to the FLP in the event of a bankruptcy, death, incapacitation or retirement of a general or limited partner
- Termination provisions
- Get the agreement signed by a certified Notary Public.
Once an agreement is created, assets can be transferred to the FLP.
- Assets typically include cash, real estate, and corporate stock.
Transfer interest ownership to your loved ones (after applying discounts for lack of marketability, control and minority interest), which can be done one of several ways:
- Apply the gifts of interest to your lifetime estate-tax exemption of $5,450,000
- Make annual gifts of $14,000 to your loved ones
- Sales to Intentionally Defective Grantor Trusts
- Since the partnership does not pay income taxes, you and all partners must pay income taxes on partnership income.
This arrangement can help you if you’re interested in preserving ownership of assets, but would like to lessen your estate tax burden, and gradually transfer asset ownership to your family members.
Contact us for further guidance on FLPs and other beneficial estate planning tools.