Family Limited Partnerships

Family Limited Partnerships: You Do Not have To Be A Hapsburg To Use This Estate and Income Tax Strategy

You Do Not Need to Be a Hapsburg to Set Up A Family Limited Partnership

Careful planning is required to set up the family limited partnership (FLP) so it meets the goals of the family. The FLP needs to be formed in compliance with the laws of the state where it will operate. After formation it is imperative that it operate in conformity with the various legal and tax laws to ensure its success at achieving its tax and financial goals.

The FLP is implemented to provide for the following business, financial and tax advantages:

Consolidated Ownership and Management

The FLP can provide for consolidated ownership and management of businesses or securities, real estate and other investments.

Transfers to Children Without Giving Up Control

FLPs can facilitate the transfer of large amounts of wealth to children or other family members without giving up management control. Children can be gifted limited partnership interests while senior family members can retain operational control through ownership of general partnership ownership interests. The limited partners have no say in the operations of the FLP, but income is allocated to them based on their ownership percentage. This allows for income being taxed at the younger generation’s lower tax bracket.

Retaining Business or Real Estate In The Family

FLPS allow the parties to keep a business or other financial assets or real estate in the family. Through the terms of the FLP agreement restrictions on the disposition of the limited partnership interests keep the real estate or other financial assets or a business within the family.

Smooth Transition to Next Generation

FLPS can ensure a smooth transition of business ownership to the next generation. By having restrictions in the FLP agreement, the transfer of limited partnership and general partnership interest can be set up and implemented before hand creating a predictable transition.

Dispute Resolution Mechanism

The FLP can provide a mechanism for resolving disputes over the disposition of assets or other operational matters. By having operational control with the general partner family disputes are usually avoided. If a dispute arises the FLP agreement provides for mechanisms to resolve such disagreements.

Shield Against Creditor Claims

The FLP can shield assets against the personal creditor claims of family members. In most states, limited partnership interests are protected from creditor claims. Creditors cannot seize or levy on a limited partnership interest. Creditors can only obtain what is called a “charging order” against the limited partners. Generally, this charging order only allows the creditor to claim any distributions made to the limited partner from the FLP, but does not allow them to reach the underlying limited partnership interest.

Tax Advantages

The FLP if structured correctly the following tax advantages may occur:

  • Estate and gift tax savings by removing appreciating assets from the estate of a senior family member
  • Utilizing the annual donee exclusion, the spousal joinder to save transfer taxes
  • Further reduction of estate and gift taxes through using various valuation discounts such as minority interest and lack of marketability discounts. These discounts can be as much as 20% conservatively speaking and sometimes more in certain cases.
  • Income tax savings by deflecting and allocating income to lower generation family members who are in a lower tax bracket than the senior family member.

Warning: Things To Do and Not To Do

The tax advantages here can be enormous if the FLP is structured correctly and the documentation is drafted with care. However, after the FLP is formed, attention to detail and following all legal formalities and documentation is essential and crucial. In addition, it is always important to document and be able to show a significant non-tax business purpose. For more on what not to do please see my companion article entitled Failures and Mistakes That Can Doom a Family Limited Partnership.

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From their offices in Philadelphia, PA, the law firm of Steven J. Fromm & Associates, P.C. provides a full range of estate planning, probate and estate administration, tax, business and corporate legal services to clients throughout eastern Pennsylvania and the Delaware Valley, the Lehigh Valley Area, the Five-County Area, Bucks County, Delaware County, Montgomery County, Chester County, Philadelphia County, Berks County, Lehigh County, Lancaster County, York County, Harrisburg, Norristown, Doylestown, Media, West Chester, Allentown, Lancaster, and Reading.