Family Limited Partnerships
A great deal is currently being written about Family Limited Partnerships. This article briefly outlines some of their uses and benefits.
A Family Limited Partnership ("FLP") is a partnership with a general partner and at least one limited partner. FLPs are generally designed to address several purposes: convenient administration of investments, while retaining control, as a vehicle for annual gifts for transfer tax planning purposes. In addition, FLPs provide for creditor protection for limited partners.
Retention of Control
A typical FLP is instituted by a senior family member who transfers business or investment assets to the partnership. The general partner has significant control over the business activities of the partnership, makes investment and management decisions and determines when distributions should be made to the limited partners. This determination is based upon the general partner's evaluation of the needs of the partnership operations. Often, the senior family member serves as general partner. However, as we will discuss below, that is not always the best way to structure the FLP.
Allocation of Profits
The taxable income of the FLP is reported annually and allocated to each partner on the basis of that partner's percentage interest. The allocation is noted on IRS Form K-1 issued to each partner. Usually, the general partner annually distributes at least enough cash to pay the income tax liability attributable to each partner. Distributions aren't taxable to the extent the partner has basis in the partnership interest. The partnership itself (unlike a corporation) is not subject to tax, because it passes through all items of income and deduction to the partners.
Individual or Corporate General Partner
A Family Limited Partnership can be the cornerstone of a family gifting program under which partnership interests are transferred to the senior family member's spouse, children, grandchildren or trusts for their benefit.
Every U.S. resident is permitted to gift up to $13,000 annually to any donee. Spouses may do the same, thereby increasing the annual exclusion to $26,000 per year per donee. This annual exclusion can be leveraged by claiming discounts on the value of the limited partnership interest gifted because of minority interest and lack of marketability discounts at the time of gift. These discounts are allowed due to the lack of control and restrictions of transfer normally associated with limited partnership interests in the FLP. This leveraging can play an important role in a senior family member's estate planning, particularly when the tax savings on any future appreciation of gifted property is considered.
Estate Tax Benefits
The same discounts used to reduce the value of gifts made during life also apply to reduce the estate tax value of transfers of FLP interests at death. The estate tax savings for claiming lack of marketability and minority interest discounts can be substantial. The percentages allowed for these discounts vary from situation to situation.
The general partner of a limited partnership bears total personal liability for debts of the FLP, to the extent that partnership assets are insufficient to pay partnership debts. The general partner can avoid personal liability by using a corporation (for example, a Subchapter S corporation) to hold the general partner interest.
While creditors can reach the personal assets of the general partner, a limited partner, by contrast, bears no liability for debts of the FLP beyond the limited partner's interest in the partnership. Generally, the only right a creditor can obtain against a limited partner is a "charging order" against the limited partnership interest, allowing the creditor to receive the limited partner's share of partner income, if any. A charging order is not always beneficial to a creditor, since the creditor receives a form K-1 from the partnership requiring the creditor to report as taxable income the limited partner-debtor's share of partnership profits, whether distributed or not.
FLPs provide creditor protection and gift-giving opportunities while also reducing transfer taxes. This estate planning vehicle is rapidly gaining popularity and should be examined in any substantial estate plan.