A Family Limited Partnership (FLP) is merely a traditional limited partnership where all the partners are family members. All limited partnerships have one thing in common – they are only run by general partners. No limited partner has any vote or voice in the running of the partnership business.
The basic structure. After the agreement is prepared, assets may be transferred, such as real estate, corporate stock, or cash. FLPs are not designed for the transfer of an individual's home, life insurance, or retirement plans. In the beginning, the parents are both the general partners and the limited partners. Then, the parents usually gift their limited partnership interests to their children.
Federal Estate Tax. The assets transferred to the FLP are out of the parent’s estate, thus, a potential avoidance or minimization of the “death tax.” (I.e. federal estate tax)
Gift Tax. The result of the assets transferred to the FLP is a completed gift made to the children. A gift tax may be due on the value of the gift. However, the parents can use their unified gift and estate tax credit to pay that tax.
Appreciation of assets. Once the gift is completed, all appreciation on the assets is out of the parent’s estate.
Immediate transfer tax saving. The value of the limited partnership interests must be less than the market value of the asset because you don’t control the money. The IRS and courts agree there must be a discount. Historically, the IRS allowed a discount of about 40%, depending upon the assets transferred. (The less liquid, the higher the discount) The result is that the parents can transfer more assets structured as limited partnership interests without paying any death taxes.
Income tax savings. The partnership itself isn't taxable - instead, the owners of a partnership report the partnership's income and deductions on their personal tax return, in proportion to their interests. For example, if the children own 99% of the limited partnership interests, they will be taxed on 99% of the income. Traditionally, the parents will be in a higher income tax bracket than their children.
Asset protection. The FLP provides asset protection. Before the parents transfer the limited partnership interests to the children, all of the assets are subject to the parent’s creditors. If the parents transfer 99% of the limited partnership interests to the children, only 1% is exposed to the parent’s creditors.
Children’s liability. If the children own say, 99% of the assets totaling $100,000, a creditor can only get a judgment called a “charging order.” This places the creditor in the same shoes as the limited partner. As general partners, the parents decide whether to distribute any cash to the limited partners. So the creditors could end up getting taxed on $99,000 in income every year, even though the general partners aren’t giving them a single penny. Thus, the creditors often settle.
Although the current federal estate exclusion amount of $5.2 million means that fewer taxpayers will have to consider whether to use an FLP to reduce their estate tax; FLP’s are still an excellent estate planning tool to provide creditor protection and potential income tax reduction savings.
If you would like to learn more about whether an FLP is the correct planning structure for your family, please call one of our experienced estate planning attorneys.
What the Attorneys of Morris Hall Can Do For You:
The attorneys at Morris Hall have 100’s of years of combined experience ensuring that families’ assets are protected from probate, unnecessary taxes, creditors, ex-spouses and Medicaid spend-down. The attorneys also help those in Arizona and New Mexico to apply for and receive Medicaid assistance and Veterans Benefits. Our Arizona offices are located in Phoenix, Mesa, Scottsdale, Cave Creek, Tucson, Prescott, Flagstaff and Arrowhead. Our New Mexico offices are located in Albuquerque, Las Cruces and Santa Fe. Contact us today at 888.222.1328 to schedule an appointment!
This blog should be used for informational purposes only. It does not create an attorney-client relationship with any reader and should not be construed as legal advice. If you need legal advice, please contact an attorney in your community who can assess the specifics of your situation.