Estate Planning for the Ultra Wealthy

Lesson 21: Example: Transferring $15M in Family Business Interests to a Family Limited Partnership (FLP), Gifting Discounted Partnership Interests to Family Members

The use of Family Limited Partnerships (FLPs) can be a highly effective strategy in estate planning for ultra-wealthy clients. This lesson explains the process of transferring $15 million in family business interests to a FLP and subsequently gifting discounted partnership interests to family members.

Introduction to Family Limited Partnerships (FLPs)

A Family Limited Partnership (FLP) is a legal structure that can help manage and transfer family assets while potentially reducing estate and gift taxes. FLPs are particularly useful for assets that are difficult to divide, such as family businesses or real estate.

Note: It is important to understand that FLPs must be structured and operated correctly to ensure that they are respected for tax purposes. Inappropriate use of FLPs can lead to challenges by the IRS.

Steps to Transfer $15M in Family Business Interests to an FLP

Here are the key steps involved in transferring $15 million in family business interests to an FLP and gifting discounted partnership interests to family members:

Step 1: Forming the Family Limited Partnership
Step 2: Contributing Family Business Interests to the FLP
Step 3: Valuing the FLP Interests
Step 4: Gifting FLP Interests to Family Members

Step 1: Forming the Family Limited Partnership

To form an FLP, the following steps are typically taken:

a. Drafting the Partnership Agreement: This agreement outlines the terms of the partnership, including the roles of general and limited partners.

b. Filing with the State: The partnership must file a certificate of limited partnership with the appropriate state authority.

Step 2: Contributing Family Business Interests to the FLP

Once the FLP is established, the family business interests can be transferred to the FLP. The family business interests are contributed to the FLP in exchange for partnership interests.

Step 3: Valuing the FLP Interests

The value of the FLP interests must be determined to calculate the potential gift tax implications. This typically involves a professional appraisal to determine fair market value, considering applicable discounts for lack of marketability and minority interest.


  graph TD
      A["Family Business Interests"] --> B["Family Limited Partnership (FLP)"]
      B --> C["General Partner Interest"]
      B --> D["Limited Partner Interests"]

Step 4: Gifting FLP Interests to Family Members

After the FLP interests are valued, the limited partnership interests can be gifted to family members. These interests often qualify for valuation discounts, reducing the overall value of the taxable gift.

Considerations and Tradeoffs

When using FLPs, it's essential to consider the following:

Control: The general partner retains control over the FLP assets.
Valuation Discounts: Proper valuation and documentation are critical to apply discounts legitimately.
IRS Scrutiny: The IRS closely examines FLPs, especially those involving valuation discounts.


  graph LR
      GP["General Partner"] --> FLP["Family Limited Partnership"]
      LP1["Limited Partner 1"] --> FLP
      LP2["Limited Partner 2"] --> FLP
      LP3["Limited Partner 3"] --> FLP

Example Scenario

Consider a scenario where a client owns a family business valued at $15 million. The client wishes to transfer ownership to an FLP and subsequently gift FLP interests to their children.

Here are the steps illustrated in this scenario:

The client establishes an FLP and transfers the family business interests to it.
The client retains a small general partner interest and divides the remaining limited partner interests among their children.
An appraiser determines the fair market value of the limited partner interests, applying discounts for lack of marketability and minority interest.
The client gifts the discounted limited partner interests to their children, potentially reducing the overall gift tax liability.

Detailed Example of the Transfer Process

Let’s walk through an example to illustrate the process step-by-step:

Step 1: Forming the Family Limited Partnership

In this step, the family works closely with legal professionals to establish the FLP. This includes:

Drafting the partnership agreement, specifying the roles and responsibilities of general and limited partners.
Filing the necessary paperwork with the state to formally create the FLP.

Step 2: Contributing Family Business Interests to the FLP

Once the FLP is established, the family can contribute their business interests to the FLP. This involves:

Transferring ownership of the business interests to the FLP in exchange for partnership units.
Ensuring proper documentation to substantiate the transfer for tax purposes.

Step 3: Valuing the FLP Interests

Valuation is a critical step to determine the gift tax implications. It involves:

Hiring a professional appraiser to assess the fair market value of the FLP interests.
Applying discounts for lack of marketability and minority interest, which can significantly reduce the value of the interests for gift tax purposes.


  graph TD
    A["Family Business Interests"] --> B["Family Limited Partnership (FLP)"]
    B --> C["General Partner Interest"]
    B --> D["Limited Partner Interests"]

Step 4: Gifting FLP Interests to Family Members

After valuation, the limited partnership interests can be gifted to family members. This includes:

Determining the number of partnership units to gift.
Executing the gift, ensuring to file the necessary gift tax returns.

Tax Implications and Benefits

The use of FLPs in estate planning offers several tax benefits, including:

Gift Tax Reduction: Applying valuation discounts can significantly lower the taxable value of the gifted interests.
Estate Tax Reduction: By transferring assets to an FLP, future appreciation of those assets occurs outside the estate, potentially reducing estate taxes.
Income Tax Planning: The general partner can control distributions, allowing for strategic income tax planning.

Warning: IRS scrutiny is a significant consideration. Ensure all steps are well-documented and valuations are conducted professionally.


  graph LR
    GP["General Partner"] --> FLP["Family Limited Partnership"]
    LP1["Limited Partner 1"] --> FLP
    LP2["Limited Partner 2"] --> FLP
    LP3["Limited Partner 3"] --> FLP

Risks and Challenges

While FLPs offer numerous advantages, there are risks and challenges to consider:

Operational Requirements: FLPs must be operated as real businesses, adhering to formalities such as regular meetings and keeping minutes.
Legal and Professional Fees: The setup and ongoing management of an FLP can be costly, requiring legal, accounting, and appraisal fees.
Family Dynamics: Managing an FLP requires clear communication and agreement among family members, which can be challenging in some cases.

Conclusion

Transferring $15 million in family business interests to an FLP and gifting discounted partnership interests to family members can be an effective strategy for ultra-wealthy clients. By reducing gift and estate taxes and maintaining control over family assets, FLPs offer significant advantages. However, careful planning and professional guidance are essential to navigate the complexities and ensure compliance with IRS regulations.