A family limited partnership (FLP) or a family limited liability company (FLLC) is an entity established under state law that is treated as a partnership for tax purposes and generally involves two or more family members. There generally are two classes of ownership: general partners and limited partners in the case of an FLP, and managing and non-managing members in the case of a FLLC. The general and/or managing partner or partners have control over the operations of the business and are personally responsible for the debts of the partnership. The limited and/or non-managing partners are not involved in the daily operation of the business and their liability is limited to the amount of capital they have contributed.
Generally, an FLP is formed by the senior members of a family who transfer an existing business or income-producing assets to a partnership in exchange for both general and limited partnership interests. Some or all of the limited partnership interests are then gifted to the junior generation. The general partners need not own a majority of the partnership interests. Thus, the general partner may own a minimal percentage of the partnership while the remaining interests are owned by limited partners.
A properly structured FLP or family LLC may provide a number of non-tax advantages, including the following:
- The donor of property to the FLP or family LLC may retain control over both the management of the underlying assets and the distributions from the entity.
- An FLP or LLC provides protection from a partner's or member's creditors. Generally, such a creditor will only be entitled to distributions that would otherwise be made to the debtor partner or member. The creditor cannot force distributions from the entity.
- An FLP or LLC may provide protection from a divorced spouse of a child or grandchild.
- FLPs and LLCs can be used to combine and coordinate a family's ownership interest in assets. Ownership of assets through an FLP or LLC would enable the general partner or managing member to manage the property on behalf of the others. This would reduce administrative costs and other issues that could result from fractional ownership of the assets.
A properly structured FLP or family LLC may also provide some significant tax advantages. FLP or LLC interests that are gifted to other family members are generally valued at less than the fair market value of the underlying assets because lack of marketability and lack of control discounts to the value of the interests are permitted. In addition, only the value of the decedent's interest in the partnership will be included in his or her gross estate upon death rather than the value of the underlying assets owned by the entity.
It is important to keep in mind, however, that the use of an FLP to reduce estate and gift tax is only possible if tax planning is not the overriding reason for the creation of the partnership. If it is, the IRS may challenge the exclusion from a decedent's estate of assets transferred into an FLP. Thus, it is critical to properly document, structure, fund and operate the FLP. The FLP must truly operate as a partnership and not just be a product of tax planning. It is also extremely important to discuss and document the non-tax reasons why an FLP is being created.
If you are interested in discussing the possibility of forming a family limited partnership as part of your succession and estate planning, please contact either Hugh Janow, Karen Rennie or Michelle Frank to schedule a free one-hour consultation.
