Lesson 79: Using Family Limited Partnerships (FLPs)

Welcome to Lesson 79 on Using Family Limited Partnerships (FLPs) as part of Business Succession Planning. This lesson provides an advanced overview of FLPs, which are commonly used in estate planning for ultra-high-net-worth individuals to effectively manage wealth transfer and minimize estate taxes.

Understanding Family Limited Partnerships (FLPs)

A Family Limited Partnership (FLP) is a partnership entity that allows family members to pool their assets, manage them collectively, and strategically transfer wealth to the next generation. An FLP is typically composed of general partners and limited partners:

• General Partners (GPs): Have control over the management and daily operations of the partnership. They bear full liability for partnership obligations.
• Limited Partners (LPs): Have ownership interest but no control over management. Their liability is limited to their investment in the partnership.

Advantages of Using FLPs

FLPs offer several benefits for high-end estate planners and their ultra-wealthy clients:

• Asset Control: GPs maintain control over the assets within the FLP, even when transferring ownership interests to LPs.
• Valuation Discounts: Limited partnership interests can often be transferred at a discount, reducing the overall value of the taxable estate.
• Creditor Protection: FLPs can provide a level of protection against creditors, as the assets are owned by the partnership rather than individuals.
• Centralized Management: Allows for centralized management and investment decisions for family assets.

Structuring an FLP

When structuring an FLP, the following steps are generally involved:

Mermaid Diagram: FLP Structure

Tax Considerations

FLPs offer several tax advantages, including:

• Gift and Estate Tax Benefits: By transferring limited partnership interests gradually, families can utilize annual gift tax exclusions and lifetime exemptions.
• Income Tax Planning: Income generated by the FLP can be distributed among family members in lower tax brackets, potentially reducing the overall tax burden.

Example: Transferring Interests with Discounts

Consider a scenario where a family business owner forms an FLP and transfers $15 million in business interests to the partnership. The partnership interests may be valued with discounts for lack of control and marketability, reducing the taxable value:

For example, with a 30% discount on a $15 million asset:

Potential Drawbacks of FLPs

While FLPs offer significant advantages, they also come with potential drawbacks:

• Complexity: Establishing and managing an FLP can be complex and require ongoing administrative effort.
• Cost: The cost of forming and maintaining an FLP, including legal and appraisal fees, can be substantial.
• IRS Scrutiny: The IRS closely examines FLPs, especially valuation discounts, which could result in audits or adjustments.

When to Use FLPs vs. Other Entities

Choosing between an FLP and other entities like a Dynasty Trust depends on the specific goals and circumstances of the client:

• FLP: Preferred when control over assets and valuation discounts are primary concerns.
• Dynasty Trust: Ideal for transferring wealth across multiple generations with creditor protection and potential asset growth.

Best Practices for Managing FLPs

Proper management of FLPs is critical to ensure their effectiveness and compliance with tax regulations. Here are some best practices:

• Regular Meetings: Hold regular meetings and maintain detailed minutes to document decision-making processes.
• Separate Finances: Keep the FLP's finances separate from personal finances to maintain the partnership's integrity.
• Annual Reviews: Conduct annual reviews of the FLP's assets, liabilities, and operations to ensure alignment with estate planning goals.
• Documentation: Maintain thorough documentation of all transactions and valuations to support tax reporting and defend against IRS scrutiny.

Example: Annual Review Process

Consider an annual review process for an FLP managing a diversified portfolio of real estate and securities:

If you're interested in a deeper dive into this subject, consider reading books on Family Limited Partnerships.

Mermaid Diagram: Annual Review Process

Case Study: FLP in Action

Let's look at a case study where an ultra-wealthy family uses an FLP to manage and transfer a large estate:

1. Forming the FLP: The family forms an FLP and contributes $20 million in real estate and $10 million in marketable securities.
2. Valuing Interests: A professional appraiser values the partnership interests, applying a 25% discount for lack of control and marketability.
3. Transferring Interests: The general partners transfer limited partnership interests to family members using annual gift tax exclusions and lifetime exemptions.

Mermaid Diagram: Case Study Timeline

Conclusion

Family Limited Partnerships (FLPs) offer significant advantages for ultra-high-net-worth individuals in terms of wealth transfer, tax efficiency, and asset control. However, they require careful planning, management, and documentation to be effective and compliant with IRS regulations. High-end estate planners should consider the unique needs and goals of their clients when determining if an FLP is the appropriate solution.

For more information on related estate planning topics, you may refer to the following lessons:

• Examples of When to Use Dynasty Trusts vs. Family Limited Partnerships (FLP)
• Tradeoffs of Family Limited Partnerships (FLP)
• Example: Transferring $15M in Family Business Interests to a Family Limited Partnership (FLP), Gifting Discounted Partnership Interests to Family Members