I am often asked about the use of limited partnerships as an estate planning tool. Limited partnerships are an attractive device in many family planning situations. Limited partnerships can be structured to provide administrative convenience, income, estate and gift tax benefits (transfers of partnership interests can be discounted for 1. Lack of Marketability and 2. Lack of Control, and can amount to a discount on the fair market value of 20% -40%, or more), as well as a measure of asset protection for the limited members. This post discusses the basics of family limited partnerships and describes some of their benefits in estate and tax planning.
A "family limited partnership" (or “FLP”) is simply a limited partnership in which typically, all of the partners are family members. Family limited partnerships are commonly used to achieve a variety of business and tax objectives. Family limited partnerships should be formed with a valid business purposes and not merely to reduce estate and gift taxation. Some of the more common "business" purposes are:
1. Avoiding Direct Fractional Ownership Over Time.
For example, direct gifts or bequests of interests in real property, can create co-tenancies (i.e. 5
siblings with fractional ownership in a residential rental). This can frustrate decision making
because all the owners of the property would need to be in agreement, if not, in-fighting may
develop. A family limited partnership provides for the general partners (parents who set up the
FLP) and not the limited partners (the next generation down from the parents), to make all of the
decisions, thus allowing control to rest with the parents.
2. Gifting Made Simple.
Many assets, particularly real estate, are not susceptible to being easily divided into multiple
shares for purposes of gift giving. Additionally, breaking up the family assets into small pieces
for gift giving fragments the assets leading to some of the management and co-tenancy problems
discussed above. Family limited partnerships fix this problem, since gifts of fractional
partnership interests are easily made. These gifts are made by gifting interests in the partnership,
not gifts of the assets in the partnership. Again, in a limited partnership the donor, as general
partner, can maintain control over the partnership, which would not be possible in a trust without
the trust being taxed to the grantor.
3. Management of Family Assets Remain at the Top.
The nature of a limited partnership is that the management is consolidated in a general partner or
partners. The limited partners may not participate in management. Therefore, a family limited
partnership allows the general partner to control the partnership and its assets, while at the same
time effectively transferring indirect ownership of portions of the assets to second and third
generation family members who are limited partners. Furthermore, the general partner will have
the power to control distributable cash flow of the partnership.
4. Avoiding Family Disputes Upon Death.
The partnership agreement could provide for an automatic succession upon the death of the
primary general partner, for succession to be determined by a vote of the remaining general or
5. Keeping Family Assets in the Family.
The very nature of a limited partnership restricts the transferability of the partnership interests
and thus the indirect ownership of the assets. Furthermore, family limited partnerships can have
buy/sell provisions which further restric transferability of the partnership interests by giving the
other partners the right to purchase any partnership interest first.
6. Protection From Creditors of Partners.
A creditor who attaches a partner's interest in a limited partnership does not become a partner and cannot vote or cause the dissolution of the partnership. The creditor's only right is to receive distributions from the partnership at such times and in such amounts as the general partner may determine.
7. Protection of Family Assets upon Divorce.
Use of a family limited partnership also simplifies characterization issues and avoids complicated
tracing problems as family assets are bought and sold over the years. Additionally, the
partnership agreement may provide that an involuntary transfer, such as a divorce court award,
may be subject to the buy/sell agreement so that the partnership interest can be purchased by the
other partners, or the divorced partner, at its fair market value, if the interest should be awarded
to the "non-family spouse."
8. Pass-Through Income Tax Treatment.
A limited partnership is a "pass-through" entity for federal income tax purposes and generally may be terminated without adverse income tax consequences. This contrasts to the often severe income tax consequences that may result on the termination of a corporation.
There are many factors in whether family limited partnerships and their uses in estate planning are right for your family. We work with attorneys and advisors to deliver the best strategy for each family. Whether a family limited partnership is appropriate in any given circumstance depends upon the goals of the particular family.