Family Limited Partnerships (FLPs) are a popular estate planning tool used by many families to transfer wealth down to future generations. FLPs offer several tax benefits that make them an attractive option for those looking to minimize their tax burden.
One of the primary tax benefits of FLPs is the ability to reduce estate and gift taxes. By transferring assets into a partnership, the value of the assets is reduced for tax purposes, which can result in substantial tax savings. Additionally, the partnership structure allows for the transfer of assets to family members without triggering gift taxes.
Another tax benefit of FLPs is the ability to take advantage of valuation discounts. Because limited partners in an FLP have restricted rights and cannot control the partnership, their ownership interest is valued at a discount. This can result in significant tax savings when transferring assets to family members.
What is a Family Limited Partnership?
A Family Limited Partnership (FLP) is a legal structure that allows families to pool their resources for business and investing purposes. It is a partnership agreement between family members who are actively involved in a trade or business. The partnership divides rights to income, appreciation, and control among the family members, according to the family’s overall objectives.
According to Investopedia, a family limited partnership is “a type of partnership that is created by family members to hold and manage family assets, such as real estate, investments, and businesses. The partnership is made up of two types of partners: general partners and limited partners.”
The general partner is usually a family member who manages the partnership and has unlimited liability for the partnership’s debts and obligations. The limited partners are family members who contribute capital to the partnership but have limited liability for the partnership’s debts and obligations.
Benefits of a Family Limited Partnership
There are several benefits of a Family Limited Partnership:
- Tax savings: One of the primary advantages of a Family Limited Partnership is tax savings. The interest that an owner grows in the business can be transferred to other individuals with no taxes incurred. Doing so reduces the business owners’ estate size, which decreases their estate tax burden. Additionally, the partnership can help reduce income taxes by distributing income to lower-income family members.
- Asset protection: A Family Limited Partnership can provide asset protection for family members. By transferring assets to the partnership, they become protected from any potential lawsuits or creditors.
- Control: The partnership allows family members to retain control of their assets while still transferring ownership to other family members. The general partner retains control over the partnership, while the limited partners have no say in the management of the partnership.
- Flexibility: A Family Limited Partnership is a flexible structure that can be customized to meet the needs of the family. The partnership can be used to hold various assets, including real estate, investments, and businesses.
Tax Benefits of a Family Limited Partnership
One of the primary benefits of a Family Limited Partnership (FLP) is pass-through taxation. This means that the partnership itself does not pay taxes on its income. Instead, the income is “passed through” to the partners, who report it on their individual tax returns. This can result in significant tax savings for the partners, as they may be able to take advantage of deductions and credits that are not available to the partnership.
Estate Tax Planning
Another tax benefit of an FLP is estate tax planning. By transferring assets to an FLP, the value of those assets is removed from the estate of the original owner. This can reduce the size of the estate and the amount of estate tax that will be owed upon the owner’s death. Additionally, the FLP can be structured in a way that allows the owner to retain control over the assets, while still transferring ownership to other family members.
Gift Tax Planning
FLPs can also be used for gift tax planning. When a partner makes a gift of their interest in the partnership to another family member, the gift is subject to gift tax rules. However, the value of the gift may be reduced by discounts for lack of marketability and lack of control. This can result in significant tax savings for the partner making the gift.
Income Tax Planning
Finally, FLPs can be used for income tax planning. By transferring assets to the partnership, the partners may be able to take advantage of deductions and credits that are not available to them as individuals. Additionally, the partnership can be structured in a way that allows for income to be allocated to partners in a tax-efficient manner.
Overall, Family Limited Partnerships offer a number of tax benefits that can help families save money and plan for the future. By taking advantage of pass-through taxation, estate tax planning, gift tax planning, and income tax planning, families can reduce their tax burden and transfer assets to future generations in a tax-efficient manner.
How to Set Up a Family Limited Partnership
Choosing the Right Partners
When setting up a family limited partnership (FLP), it is important to choose the right partners. The partners should be family members who are interested in working together to achieve common financial goals. It is also important to choose partners who are financially responsible and trustworthy.
One advantage of an FLP is that it allows for the transfer of assets to the next generation without losing control of those assets. Therefore, it is important to choose partners who share the same vision for the future of the partnership and who are willing to work together to achieve those goals.
Drafting the Partnership Agreement
The partnership agreement is a legal document that outlines the terms and conditions of the FLP. It is important to consult with a lawyer who specializes in estate planning to draft the partnership agreement.
The partnership agreement should include the following:
- The purpose of the partnership
- The rights and responsibilities of each partner
- The distribution of profits and losses
- The transfer of partnership interests
- The dissolution of the partnership
The partnership agreement should also include provisions for the management of the partnership. This includes the appointment of a general partner who is responsible for managing the day-to-day operations of the partnership.
Transferring Assets to the Partnership
Once the partnership agreement has been drafted and signed, the next step is to transfer assets to the partnership. This includes cash, securities, real estate, and other assets that the partners wish to include in the partnership.
It is important to consult with a tax professional before transferring assets to the partnership. The transfer of assets may have tax implications, and it is important to understand these implications before making the transfer.
Once the assets have been transferred to the partnership, the partners can begin to enjoy the tax benefits of the FLP. These benefits include the ability to transfer assets to the next generation without paying gift or estate taxes, as well as the ability to reduce income taxes through the use of the partnership’s tax structure.
Family Limited Partnerships can be a powerful tool for estate planning and asset protection. By pooling assets together, families can take advantage of tax benefits and reduce their estate tax burden. FLPs can also help families consolidate and coordinate their assets, making it easier to manage and transfer wealth to future generations.
However, FLPs are not without their drawbacks. Setting up and maintaining an FLP can be complex and expensive, and the IRS closely scrutinizes these structures to prevent abuse. Families considering an FLP should consult with a tax professional and attorney to ensure compliance with all relevant laws and regulations.
Despite these challenges, FLPs remain a popular option for families looking to protect and transfer their wealth. With careful planning and execution, an FLP can provide tax benefits and asset protection for generations to come.