Family Limited Partnership

A Family Limited Partnership is formed to hold the family business or investments, and the parents can make gifts of their limited partnership interests to their children to save on federal gift and estate tax.

Family Limited Partnerships also have some attraction as asset protection vehicles, primarily because the limited partnership interests may be subject to “charging order protection” in some states.  Like with a tradition LLP or LLC, charging order protection prevents a creditor from reaching the assets of the FLP – the creditor can only reach a distribution of that specific creditor.  Moreover, where no distribution is made the creditor will pay taxes on allocated income.  For instance, if the kids are included in a lawsuit.  If the partnership earns $100,000 and the limited partner owns 99%, the creditor is going to be taxed on $99,000. But as cooperative general partners, the parents can (and should) decide not to distribute any cash to the limited partners. This means the creditors could then end up getting taxed on $99,000 in income, even though the general partners aren’t giving them a single penny.

When utilized correctly, FLPs can be very powerful estate planning and asset protection planning tools. The problem is FLPs are almost never correctly utilized, and because of this they often fail to produce their promised benefits.  With the proper legal counseling and a properly drafter Partnership Agreement, you can be sure that you will be using your FLP correctly.

All limited partnerships are run by general partners while Limited partners do vote and cannot control the running of the partnership business. A general partner, who may own only 1% of the partnership assets, will still control 100% of those assets.

In the typical family limited partnership situation, the parents put their assets into the partnership. They start by being both the general partners and the limited partners. Then the parents gift their limited partnership interests to their children.

Even after giving away limited partnership interests to their children, the general partners (parents) still retain full control over all of the assets.  The limited partners (who become the general partners upon the death of both parents) own and have title to the limited partnership interests.

  • The assets are essentially out of the parents’ estates and completed gift of limited partnership interests has been made to their children. While a gift tax may be due on the value of the gift, the parents can use their unified gift and estate tax credit to pay that tax. In 2010 this credit became unlimited, but is scheduled to be reduced to only $1,000,000 in 2011 unless Congress votes otherwise.
  • Since the gift was completed, all appreciation on the assets is out of the parents’ estates.  This means that all appreciation of assets that would otherwise increase the value of the parent’s estates is removed from their estates.

According to law, the value of limited partnership shares can be discounted when transferred to family members. In addition, because of an FLP’s flexibility, the family members who are owners can usually amend the partnership agreement as family circumstances change.  And in the event of a divorce, where a limited partner ceases to be a family member, a properly drafted Partnership Agreement can require a transfer back to the family for fair market value, keeping the asset within the family structure.

After the agreement is prepared, assets may be transferred, such as real estate, corporate stock, or cash. FLPs are not designed for the transfer of an individual’s home, life insurance, or retirement plans.

The general partnership interests are retained by the senior partners for their lifetime, while the limited partnership interests are given as gifts over time to the limited partners.

It is important to understand, though, that the limited partners (children) will be taxed by the IRS on their portion of income (usually 99%).  This saves the General Partners (parents) a significant amount in taxes since traditionally, the parents will be in a higher income tax bracket than their children.