I am often asked about using 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 various business and tax objectives. Family limited partnerships should be formed with valid business purposes and not merely to reduce estate and gift taxation. Some of the more common "business" purposes are:
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 agree, 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.
Many assets, particularly real estate, are not susceptible to being easily divided into multiple shares for gift-giving purposes. 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 the general partner, can maintain control over the partnership, which would not be possible in a trust without the trust being taxed to the grantor.
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 the partnership's distributable cash flow.
The partnership agreement could provide for automatic succession upon the death of the primary general partner, for succession to be determined by a vote of the remaining general or limited partners.
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 that further restrict the transferability of the partnership interests by giving the other partners the right to purchase any partnership interest first.
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.
Using 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."
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 with the often severe income tax consequences that may result in 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.