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Published on: 05/08/2024 • 8 min read

What is a Family Limited Partnership (FLP)?

What is a family limited partnership? A Family Limited Partnership (FLP) is a high-level financial planning tool predominantly used by high-net-worth families seeking to manage their assets, minimize taxes, and facilitate a seamless wealth transition across generations. 

At its core, an FLP involves the creation of a partnership entity by family members who then contribute assets to this entity in exchange for partnership interests. This structure not only offers protection from creditors but also allows for significant tax benefits and control over the management of the family’s assets. 

In this article, the wealth managers from Avidian Wealth Solutions will explore family limited partnerships, highlighting their benefits as an estate planning solution, potential drawbacks, and why they’re considered an essential component of estate planning for affluent families. 

What is the difference between a family limited partnership vs. an LLC?

The primary difference between a Limited Liability Company (LLC) and a Family Limited Partnership (FLP) lies in their structure and the level of control they offer. An LLC is a flexible business entity that provides limited liability to its owners (members) and can be owned by one or more individuals or entities. It allows for a more straightforward management structure and offers protection against personal liability for the business’s debts. 

On the other hand, an FLP is explicitly designed for family-owned assets, with a general partnership (GP) and limited partners (LPs). The GP, typically parents or grandparents, retains control over the management of the assets, while the LPs, often children or grandchildren, hold shares in the partnership without significant control over its decisions. 

This structure of an FLP facilitates not only asset protection and estate planning but also introduces opportunities for teaching younger generations about wealth management.

How do family limited partnerships work?

Family limited partnerships operate on a straightforward yet effective premise. As mentioned, the partnership is established between two types of partners: general partners, who manage the partnership and its assets, and limited partners, often the children or grandchildren, who invest in the partnership but do not partake in its management. 

This distinction is critical as it allows the general partners, typically the parents or senior family members, to retain control over the assets while simultaneously transferring some of their estate to the next generation, potentially reducing estate taxes upon their passing.

The process begins with the transfer of assets (real estate, stock portfolios, or even businesses) into the FLP. These assets are then managed by the general partners, who also decide on any distributions to the limited partners. Such distributions can be an efficient way to transfer wealth to the next generation while the senior family members are still alive, again potentially reducing the size of their estate for tax purposes.

Continue reading: How to keep a property in the family forever

What is an example of a family limited partnership?

Let’s say that a parent establishes a Family Limited Partnership (FLP) and transfers their assets into it. The general partner of the FLP is a limited liability company, solely owned by the parent, while the parent takes on the role of the sole limited partner. 

In the subsequent year, the parent opts to make annual exclusion gifts by distributing limited partnership interests to their children. An appraisal of the FLP reveals that the value of limited partnership interests should be discounted by 35% due to restrictions on control and marketability. 

Consequently, the parent can gift $66,000 worth of limited partnership interests to their children, which, within the context of the family, effectively holds a value of $88,000.

Potential benefits of forming an FLP

Forming a Family Limited Partnership (FLP) as part of succession planning for a small business offers a multitude of benefits, which can include:

1. Control and flexibility

One of the unique benefits of a family limited partnership is its flexibility and ability for the general partners to retain control. More specifically, older family members, the general partners, can retain control of the business and its assets while the younger family members, the limited partners, learn the business so that they can eventually run it themselves. 

Parents always have the option to give away their estate while they are still alive; however, by doing so, they lose control of the assets and they will not be able to protect the business or assets from unintended beneficiaries. 

The family limited partnership, through the creation of an effective partnership agreement, can state how the business is to be distributed to partners for purposes of a smooth transition. A partnership agreement can give all children a share of the business through their limited partnership interest, but one child can receive a salary for her work and assume the role of a general partner upon the death or retirement of one or both parents. 

Additionally, the family limited partnership allows the family’s assets to be consolidated and centralized. Any changes that are needed concerning family control can simply be done by changing the general partners.

2. Privacy

Privacy is a huge concern for many families, particularly high-net-worth ones, when it comes to financial matters and business affairs. A Family Limited Partnership (FLP) offers an enhanced level of privacy by keeping the family’s financial and business dealings out of the public domain. 

Unlike corporations, which are required to file annual reports and other documents that become public records, an FLP’s financial and operational details are not subject to the same level of public disclosure. This aspect of an FLP can be particularly appealing for families seeking to maintain confidentiality around their wealth and business strategies. 

Furthermore, in the event of legal disputes or challenges, the FLP structure can provide an additional layer of privacy, as the details of the partnership and its assets are less accessible to outside parties. This inherent privacy can be a key advantage in helping to preserve the legacy and integrity of family assets across generations.

3. Tax advantages

One of the primary advantages of an FLP is the potential for estate tax savings. Since partners can gift shares of the partnership to their heirs, this can reduce the size of the estate and, consequently, the estate tax liability upon the death of the partners. These gifting strategies can utilize annual gift tax exclusions, further minimizing the tax impact on the family’s wealth. 

Additionally, the valuation of FLP interests will reflect a lack of marketability and control, which results in lower values for tax purposes. The lower value of limited partner interests is advantageous when transferring wealth to the next generation, as it results in lower gift and estate taxes.

An FLP can also help consolidate family assets into a single entity, potentially simplifying management and administrative processes. This includes simplifying tax reporting when the FLP contains more than one business entity.

However, it’s important to note that the IRS scrutinizes FLPs closely, especially those that appear to be set up solely to evade taxes. Proper establishment and operation within the legal framework are critical to avoid penalties and ensure that the FLP achieves its intended financial and estate planning objectives.

4. Valuation discounts

One of the most compelling reasons for establishing a Family Limited Partnership (FLP) involves the potential for valuation discounts. 

Because the limited partnership interests are often not marketable outside the family and lack control over the partnership decisions, these interests can be valued at a discount when being transferred to heirs or other family members. This means that the actual market value of these interests can be significantly higher than the value assigned for tax purposes. This discount plays a crucial role during the transfer of wealth, as it can lead to substantial gift and estate tax savings. 

To leverage this benefit effectively, it’s important that these discounts are carefully calculated and properly documented to withstand scrutiny from tax authorities. Proper valuation of FLP interests requires a thorough understanding of both the tangible and intangible assets held within the partnership and an analysis of the lack of marketability and control associated with these interests. 

This strategic advantage not only aids in wealth preservation but also in a more seamless transfer of assets to the next generation, ensuring the family’s financial legacy is upheld.

What is the downside of a family limited partnership?

Despite the numerous benefits offered by FLPs, several disadvantages of family limited partnerships should be considered before setting one up, including:

1. Complexity and cost

One of the primary considerations to be made regarding FLPs is the complexity and cost of establishing and maintaining them. The process requires legal and accounting expertise to ensure compliance with tax laws and regulations, which can be expensive and time-consuming. Additionally, FLPs require ongoing management and administration, including the preparation of annual tax returns and other regulatory filings, which can add to the operational costs.

2. Potential for family disputes

Another potential drawback is possible conflict within the family. Since FLPs involve shared ownership and management of assets, differing opinions and interests among family members can lead to disputes. Managing these relationships effectively is crucial to the smooth operation of an FLP and maintaining family harmony.

3. IRS scrutiny

FLPs are subject to scrutiny by the IRS, particularly if they are perceived as mechanisms for tax evasion rather than legitimate estate planning tools. This scrutiny can lead to audits and potentially adverse tax consequences if the FLP is not structured and operated correctly.

Looking for effective family limited partnership estate planning? Let’s talk.

So, what is a family limited partnership (FLP)? While family limited partnerships face challenges like potential conflict, IRS scrutiny, and transfer restrictions, they remain a powerful estate planning tool that can offer significant tax advantages, asset protection, and the fostering of a family legacy when structured and managed wisely.

At Avidian Wealth Solutions, our team of seasoned financial advisers is poised to offer tailored solutions that can help navigate the complexities of FLPs so that your estate planning can better align with both your financial goals and the well-being of your family. 

Our wealth management family office experience and service model extends beyond FLPs, encompassing comprehensive estate planning, business succession planning, wealth management, and tax optimization strategies.

Partnering with Avidian Wealth Solutions means entrusting your legacy to experienced professionals dedicated to crafting a robust framework that works for your family’s future wealth and security. 

Schedule a conversation with us today to explore how we can help mold these strategies into a powerful legacy for you and your loved ones.

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