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Family Limited Partnerships
Family Limited Partnerships or FLPs are a very effective method of transferring interests in businesses, at a discounted value, to other family members, while at the same time retaining management and control with the original holders. Although they are available to all, not everyone will find a FLP useful for their unique situation.
Basically, in a FLP other family members (usually the children of the original owners of the business) buy or are gifted partnership interests in the family business, keeping in mind the appropriate annual exclusion amounts for gifts. The interests can be gifted each year to help reduce the total estate of the parents, which aids in minimizing, and in some cases eliminating the federal estate tax due at the death of the parents, who in this scenario are the original owners of the business.
Let’s illustrate a FLP by way of an example. Husband and wife have an existing business. Each year they gift interests in the business to the children and their spouses, or perhaps even their grandchildren. Because the interests given are (or should be) minority interests, with limited powers and decision making authority, the shares are worth less than their actual value. This reflects a lack of liquidity and marketability associated with these particular shares. A minority interest in a business with limited powers and decision making authority is certainly not worth as much on the open market as shares with no limitations. This allows husband and wife to give more property than it would appear, because if the children were to try to sell their minority interest, a willing buyer would offer less due to of the lack of control over the business. The parents (who happen to be general partners) retain all of the decision making authority for the business. They can receive a salary, make loans to themselves, or distribute income to the limited partners. This transfer, if done year after year, can reduce the parents’ estate considerably without reducing their control in the business.
There are some downsides associated with utilizing an FLP, especially when FLPs own “highly appreciated property,” known as property that has grown in value since it was purchased. Normally, property that passes at death passes with a full “step up” in basis. That is to say that the property passes at the date of death value, not at the value of what the decedent paid for the property. Using a FLP can create a capital gains tax problem. Property gifted, as with a FLP, retains the parents’ basis, or what they originally paid for the business. Suppose husband and wife put a five acre parcel of land into the FLP. They bought the parcel twenty years ago for $5,000, and today it is worth $100,000. When husband and wife die, the capital gain on the sale of the parcel will be computed on their basis ($5,000, not $100,000, the value of the property when transferred). When the property is sold by the children the capital gain will be computed on a basis of $5,000. Thus, if the property sells for $100,000 there will be a capital gain of $95,000. That gain will be taxed accordingly. This problem will not exist if the property passes via an instrument like a Will, because the children will take the property at the date of death value of $100,000, which would not create a capital gain tax issue. Care should be used with what property is placed into a Family Limited Partnership.
If utilized correctly FLPs can be an extremely effective estate planning tool. FLPs help estate planners to assist their clients in transferring wealth to future generations, while at the same time minimizing the tax consequences of the transfer, but only if you are careful. Competent counsel should be sought to advise you on the use of a Family Limited Partnership that is tailored to your specific situation.
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