A family limited partnership is a legal business entity that allows family members to pool assets in order to run a business venture. Each member owns shares of the partnership (which do not need to be equal) and each profits in proportion to the shares owned.
An operating agreement establishes general partners and limited partners. The general partners maintain authority over management decisions even if they own only 1%. Limited partners do not engage in management decisions; however, they can receive distributions and enjoy certain tax advantages as well as protection from creditors.
Advantages of Family Limited Partnerships
Asset Protection
A creditor of one of the members of the partnership cannot access the assets held in the partnership. Since the partnership is considered a separate legal entity, a member’s interests in it are not considerable marital property in Maryland which prevents a spouse from gaining access in the event of divorce.
Estate & Gift Tax Savings
One of the most significant advantages is that a family can reduce the value of gifts thereby reducing the taxable estate and taxes owed. The gifts are made using the annual exclusion, which in 2022 is $16,000 per year per person. For example, a couple creates a family limited partnership and gifts limited partnership shares to their 3 adult children and 6 grandchildren. Each year the couple could gift $32,000 to each of the 9 family members of FLP shares. That equates to $288,000 per year leaving the taxable estate.
Even more advantageous, the value of the shares gifted can be discounted. The IRS requires a gift to reflect fair market value; however, limited shares of a family limited partnership are not considered as valuable as shares in a publicly traded company. This is based on the fact that a willing buyer is not going to pay as much for a fractional interest in a closely held business.
Alternative Dispute Resolution
The operating agreement can state that only a certain type of alternative dispute resolution can be used. This prevents family squabbles from being exposed to public litigation which also reduces legal costs.
Management Training
These legal entities allow senior family members to continue management as they teach younger generations to take over the business. These are often used in business success planning and continuity planning.
Having a family limited partnership created and the documents drafted can be very complex. It must be done correctly or could end up being scrutinized by the IRS. Some issues the IRS considers when assessing the legitimacy of an FLP include:
- You can show there is a legitimate, non-tax-related reason behind creating the FLP. While tax savings are important, you should be able to demonstrate other reasons for the FLP.
- The FLP must be a legitimate business entity created to fulfill a business purpose. No personal assets should be titled in the FLP and the assets in the FLP should not be used to pay for personal expenses.
- All assets in the FLP should be professionally appraised, especially those used in discounted gifting strategies.
Contact the estate planning attorneys at Stouffer Legal to discuss how a family limited partnership may be included in your estate plan. You can schedule an appointment by calling us at (443) 470-3599, emailing us at office@stoufferlegal.com, or register for an upcoming free webinar using the link below:
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