The Benefits of a Family Limited Partnership
Years ago, a family limited partnership (FLP) was little more than a clever loophole used almost exclusively by wealthy persons. But the FLP's mystique has diminished in recent years, making it a popular and effective estate-planning tool for many.
Obviously, you must plan carefully to avoid puffing your assets in penl or stepping on the tax collector's toes. But establishing an FLP can offer remarkable protection and tax savings. Let's look at the details.
What's in It for Me?
A significant restructuring of your assets may seem an imposing concept. But the potential tax savings make it worth a look. Essentially, an FLP allows the future appreciation of assets to be transferred to younger family members. It also redistributes income from older taxpayers in higher tax brackets to children and grandchildren who may be in lower brackets.
You can use the annual gift tax exclusion of $10,000 (annually indexed for inflation, though inflation has not yet increased enough to raise the exclusion to $11,000) and the unified gift and estate tax credit of $675,000 in 2000 (that will gradually increase to $1 million by 2006) to transfer assets to the next generation. And you may even obtain minority interest and lack of marketability valuation discounts for gift tax purposes on the value of transferred partnership interests.
The tax credits available are considerable. A properly structured FLP allows single-level income taxation and avoids:
- High income tax rates applicable to trusts,
- Corporate double taxation, and
- The complexities of applying for S corporation status.
A Safe Place for Your Money
Forming an FLP is like constructing a specially protected area in which to carry out your financial transactions. You can transfer assets - such as cash, stocks, bonds or real estate - under the FLP umbrella in exchange for general and limited partnership interests.
You can also make gifts of all or any part of the limited partnership interest.
And your FLP even protects the gift's value. After all, a gift made under an FLP is valued according to what a hypothetical, unrelated buyer would pay for it. The value is discounted because the limited partners can't control the FLP assets or the distributions they receive, or force a partnership dissolution. The discount rate ranges from 10% to 50%, resulting in a reduction in asset valuation for gift tax purposes.
You Have the Power
Obviously, all these benefits require great care. When you establish an FLP, you become the general partner with the power to decide how the FLP operates, when limited partners or members receive distributions and who can cash in FLP interests. A drawback to being the general partner of an FLP is that you assume not only control but also unlimited liability.
Personal liability is a typical worry of any- one setting up an FLP. To protect your assets, consider setting up a corporation to act as general partner. Then, as president of 9' the corporate general partner, you can run the FLP without personal liability.
But the IRS Is Watching You
The IRS keeps a close eye on FLPs. Discounts are not available to taxpayers whose only motivation is to avoid paying tax. And if the FLP is to stand up in court, you will need one or more valid business reasons for setting it up.
Legitimate business reasons include the need to manage assets more efficiently as well as retain family ownership and protect assets from future creditors, failed and second marriages, and legal liability. Remember, the IRS will not recognize deathbed transfers on the ground that last minute FLPs are created solely to obtain valuation discounts and avoid estate tax.
FLP Planning Issues
Besides benefits, setting up an FLP also creates issues you should consider before you begin. For instance, who will be the general partners? Choose them carefully because they will exercise exclusive control over the partnership, determine distribution amounts and timing, and assume unlimited liability.
FLP partners can include trusts, custodian- ships and other entities organized for family members.
If your FLP includes assets located in different states, consider exactly where to best organize the partnership. This is an important consideration because state governing statutes differ. Also, operating a partnership in some states may subject you to an entity- level income tax.
And, of course, decide in advance what pro- visions to include in the FLP. Proper drafting of the agreement is key to accomplishing your management objectives and allowing the valuation discount to withstand an IRS challenge. And don't forget a succession plan. Designate a nonmanaging general partner to succeed in the management and control duties if the general partner's interest is transferred.
All In the Family
We hope that the recent economic boom has contributed handsomely to your estate. But more money means greater danger, especially when it comes to tax liability.
More and more taxpayers are turning to FLPs to protect their family's assets and keep more money in their pockets and out of Uncle Sam's. For a more detailed description of how an FLP could help you, please call us.