If you’re estate planning, odds are you’re looking for the most advantageous way to pass on your assets to your heirs. A family limited partnership is one option some families use to plan their futures.
But what is a family limited partnership? What are the pros and cons of using one, and how does it compare to other estate planning tools? In this guide, we’ll walk you through the basics of a family limited partnership.
A family limited partnership (FLP) is a limited partnership with partners who are all related. In the eyes of the state, an FLP is no different from a standard limited partnership. However, practically speaking, the family limited partnership differs because even though it’s a business entity, it’s often used as an estate planning tool.
Every family limited partnership has two types of partners: general partners and limited partners.
In any limited partnership, general partners are the individuals responsible for managing the day-to-day operations of the business. They assume personal liability for the business (unless they’ve created an LLC as the GP), but they have much more control over how the business assets and operations are managed.
In the context of an FLP, general partners can be the parents who want to use the partnership as a means of passing on an inheritance to their heirs.
Limited partners are less involved in the management of the LP. While they do have an economic interest in the partnership, they typically aren’t involved in decision making. Limited partners are typically only liable to the extent of their capital contributions to the partnership.
Generally, in a family limited partnership, the heirs are limited partners in the estate. The roles and statuses of each limited partner and the general partners are dictated by a partnership agreement.
If formed properly and managed in compliance with applicable requirements and the partnership agreement, family limited partnerships can offer several benefits:
A key benefit to creating an FLP is the tax advantages the structure provides. For starters, any income or losses generated by the partnership are subject to pass-through taxation. In addition, general partners can utilize the partnership to gradually transfer partnership interests to the limited partners in the form of gifts. In the context of estate planning, this structure reduces gift and estate taxes while allowing the general partners to maintain control over the management and distribution of the partnership’s assets.
Creating an FLP doesn’t offer the same limited liability protection as a corporation or limited liability company (LLC), but it does still offer some. In a limited partnership, the general partners have personal liability for the business’s activities. Creditors could come after the general partner’s personal assets for business liabilities. However, if correctly drafted, assets transferred to the limited partnership are protected and beyond the reach of any future creditor.
Limited partners are not personally liable but, instead, have limited liability. They are only liable for debts incurred by the partnership to the extent of their investments in the company. With that being said, it’s important that general partners are treated differently from limited partners when it comes to the amount of control a limited partner is able to have over the partnership.
When you set yourself as a general partner of your FLP, you maintain control of the business. Within the partnership agreement, you can set the terms for how and when the limited partners benefit from the partnership. You can dictate how much each partner receives, if their spouses get joint ownership, and more.
It’s very important to have a carefully prepared agreement, as this document dictates the fate of all the assets both before and after a general partner’s death. Often, these agreements make contingency provisions for a partner’s divorce, dependents, and other scenarios. The partnership agreement can also be amended from time to time as needed.
There are some unique complexities to forming an FLP, and it may not be the right structure for everyone.
Creating and maintaining a family limited partnership can be complicated. As discussed earlier, a partnership agreement needs to be drafted. That document alone requires professional legal guidance.
Additionally, you’ll need to enlist the help of an experienced financial advisor and accountant to help structure the partnership and tax strategy, estimate gift and estate taxes, and assess the impact of any future transactions involving the partnership. You’ll most likely also want to enlist a lawyer to plan your estate. While hiring this suite of professionals is costly, it can save you from more expensive (and time-consuming!) probate and tax complications in the future.
If you’re looking for personal liability protection for each member of the business, an FLP isn’t the right business structure for you. That’s because a general partner takes on personal liability for the entity’s activities. If the FLP gets into legal or financial trouble, the general partner(s)’ personal assets could be in jeopardy. Understanding options to limit liability and insulate assets is one reason why estate planning is so important for family business owners.
The IRS imposes an annual gift tax exclusion limit. For the 2023 tax year, that limit is set at $17,000 or $34,000 per married couple per gift recipient. That means you and your spouse could give 10 different people $34,000 each and pay no gift tax for tax year 2023. However, if you exceed the annual gift tax exclusion in any given year for any specific person, it may count against your unified lifetime estate tax and gift tax exemption.
This is why it’s important to be intentional about what assets are put in the FLP. Instead of gifting money directly to your heirs, you can use FLPs to increase the amount of your gift. To do this, you may want to consider putting into the FLP assets that will appreciate in value and generate future revenue. Then, you can gift shares or interest in the FLP to your heirs or limited partners.
LLCs, trusts, and irrevocable trusts are three other options that are commonly used in estate planning. Let’s take a quick glance at each.
A limited liability partnership is different from a family limited liability company (LLC), primarily in terms of liability and ownership. Like a limited partnership, an LLC can be used to “gift” assets to heirs gradually, potentially causing a tax savings on the overall estate tax burden. Each member of an LLC can be shielded from personal liability (unlike an FLP), but there can be fewer control opportunities by the estate owners.
The choice of whether to use an FLP or an LLC for estate planning purposes depends on the LLC’s structure requirements under state law. Either entity type can be used to accomplish a client’s estate planning objectives and is one of the most used techniques to shelter assets from a taxable estate.
A trust is a legal entity that holds property in order to benefit another person (or party). There are several different types of trusts: revocable, living, irrevocable, and more! It’s incredibly important to work with financial, tax, and legal professionals to determine what elements you need in your family trust to meet your needs. A trust is managed by a trustee for the sake of one or more beneficiaries. Some assets can’t be added to the trust, including certain retirement plans and assets that you own jointly with others. In addition, in most states, heirs have a longer period of time to contest the distribution of proceeds from a trust.
Here at ZenBusiness, we help take away the red tape side of businesses. While we can’t form your family limited partnership for you, we have many business services that can help you with planning for your future. Check out what we have to offer today.
Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
The biggest drawback to an FLP is simply that it’s a complicated business entity type. To set up one that actually benefits your estate and accomplishes the tax breaks you want, you’ll need the help of an estate planning attorney and most likely a financial planner and tax advisor.
Forming an FLP can be a useful tool in estate planning, especially when it comes to maintaining control of the distribution of assets while potentially lowering estate and gift taxes.
By gradually handing over a stake in the family assets, a parent can reduce the size of their taxable estate and give their heirs relief from certain estate taxes. Additionally, any losses or profits generated by the partnership are subject to pass-through taxation.
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