Certified Document Services
In recent years, Limited Partnerships or "LPs" have become an increasingly popular choice for businesses—especially those involved in real estate or other investment ventures. The main reason is that unlike general partnerships, limited partnerships (as the name suggests) have the ability to limit both the liability risk and the business involvement of certain partners known as "limited partners." This feature is particularly useful for attracting investment partners who'd like to participate in the profits of the business but not necessarily its risks or daily operations.
A relatively new form of limited partnership—the Family Limited Partnership (FLP)—has also gained popularity in recent years. Designed more as a wealth transfer strategy than a business structure, the FLP allows individuals to transfer personal or business assets into a partnership and then grant limited ownership interests to their children or other family members. This not only works to lower the taxable value of your estate, but also ensures that certain assets remain in the family.
What is a Limited Partnership?
A Limited Partnership is a business entity comprised of two or more partners who operate or manage a business together. In every Limited Partnership (LP), there are two types of partners—general partners and limited partners.
What is a General Partner?
General partners control the company's day-to-day operations and take on the legal debts and obligations of the business. In other words, they run the show. Because they are responsible for any debts or lawsuits incurred by the company, general partners often form corporations or LLCs to protect themselves from liability.
What is a Limited Partner?
Limited partners contribute capital to the partnership but do not participate in the daily operations of the company. As an added benefit, they are also shielded from company debts and other liabilities. Limited partnerships are a great choice for individuals who lack the time or expertise to run a business but would like to share in the profits.
What is the advantage of forming a Limited Partnership?
Disadvantages of a Limited Partnership
Taxation of Limited Partnerships
For tax purposes, a Limited Partnership typically works like a general partnership. Profits are "passed through" to the partners who report the income on their personal tax returns. Limited Partnerships are frequently formed to acquire, operate and hold real estate.
What is a Family Limited Partnership?
Although not officially recognized by the IRS, the term "Family Limited Partnership" or "FLP" is frequently used by financial planners to describe limited partnerships that are set up specifically to hold family businesses or investments. The idea is that individuals can use an FLP to bestow limited partnership interests as gifts to their children. In recent years the Family Limited Partnership has become an extremely popular wealth transfer strategy. With an FLP, individuals can reduce the taxable value of their estate by placing their assets in a limited partnership and then allocating ownership interests to other family members. For parents, it's an effective way to lower their tax burden while ensuring that family businesses or personal assets remain in the family.
As with conventional limited partnerships, family limited partnerships are comprised of both general and limited partners. The only difference is that these positions are held by family members. To form a limited partnership, members must file a certificate with the state. Once formed, the FLP is considered a legally distinct entity and assigned a tax identification number. The FLP can then own assets and conduct most business activities.
How is an FLP formed?
As with conventional limited partnerships, family limited partnerships are comprised of both general and limited partners. The only difference is that these positions are held by family members. To form a limited partnership, the partners must file a certificate with the state. Once formed, the FLP is considered a legally distinct entity and assigned a tax identification number. The FLP can then own assets and conduct most business activities.
How is an FLP taxed?
A Family Limited Partnership is typically taxed like a general partnership. Profits are passed directly to partners based upon their ownership interest and reported as personal income on their individual tax returns. Unlike a corporation, there is no corporate tax imposed on a Limited Partnership. And unlike with an S Corporation, taxes are not collected on assets that pass from the partnership to its partners.
The Partners in an FLP
General Partners (typically the father, mother or both) create the partnership specifically to gift limited partner shares to their children or other family members. General partners retain control of the FLP and make day-to-day investment decisions. They can also draw a percentage of the FLP's income in the form of a management fee.
Limited Partners (typically children or other family members) have an ownership interest in the FLP but limited or no control over the partnership's management. They receive a share of income generated by the FLP based upon their ownership percentage. When the FLP dissolves, a proportionate amount of FLP property will pass to each limited partner.
Setting up an FLP
Setting up an FLP requires placing your assets into the partnership using your estate tax credit. For example:
A husband and wife can each transfer up to $1,500,000 ($3 million total) into an FLP without paying estate taxes and then allocate those assets to the limited partners. They can then place a smaller amount (typically 1% of total assets) into the FLP and assign ownership of this amount to the general partners. There are usually no taxes incurred when funding an FLP as long as you do not exceed the maximum contribution.
At first, you and your spouse own both general partner and limited partner shares. Over time, you can grant your family members limited partner shares using your annual $11,000 gift exclusion. Don't worry about giving away too many of your shares. Based on current tax law, general partners may own as little as 1% of the FLP's assets and still retain control of the partnership. That means you can still buy and sell assets, dispose of property and distribute additional FLP shares.
It's important to note that FLPs have come under increasing scrutiny by the IRS, which is always on the lookout for abusive tax shelters. To avoid unwanted scrutiny, be sure to take care when assessing the value of your assets (see section on Estate Tax Credit).
What type of assets work in an FLP?
Any type of business or investment asset can work in an FLP. Assets related to an operating business, such as a store or ranch, work particularly well. But some families set up an FLP solely with investment-type assets. When making decisions about how to fund the partnership, it's very important to understand the difference between Safe Assets and Dangerous Assets.
These are assets that do not by themselves carry a high degree of lawsuit risk. For example, if you own investment securities such as stocks, bonds or mutual funds, it is highly unlikely that these assets alone will ever put you at risk for a lawsuit.
Dangerous assets are those that carry an inherent and substantial liability risk. These are generally active, business-type assets such as rental property or motor vehicles—both of which could invite a lawsuit. Many people choose to either remove dangerous assets from their FLP or set up separate FLPs to isolate dangerous assets from each other and from safe assets. The reason is this: If a dangerous asset winds up the target of a lawsuit, all of the assets in your FLP become vulnerable to a lawsuit judgment.
Estate Tax Credit
In many cases, you can contribute more than the maximum $1.5 million ($3 million per couple) Estate Tax Credit by transferring a greater ownership percentage to your limited partners. The logic works like this: A gift of $1.5 million in limited partnership interests is worth less than $1.5 in general partnership interests. After all, limited partner shares do not come with any decision-making powers and cannot be sold or transferred to others. In other words, there is no "market" for limited partner shares so you can appraise them at a lower value. This practice of appraisal reduction is often referred to as "discounting" the value of limited partnership units. But be careful not too discount too heavily as this could raise red flags at the IRS and potentially invalidate your FLP.
Advantages of creating an FLP
Advantages of creating an FLP include:
How can a Family Limited Partnership help your family?
FLPs are ideal for families who own business assets in common. This includes assets they one day wish to pass down to other family members.
FLPs can protect partners from lawsuits, creditors and divorce claims.
Say a father sets up a Family Limited Partnership. He is both a general partner owning 1% and a limited partner owning 90% of the partnership. Each of his children own 4.5% of the company. The following protections can apply:
1. If the father is sued, in most cases creditors cannot seize his partnership assets provided the partnership was set up before the creditor problems began.
2. If one of the children divorces or is subject to creditor claims, the ex-spouse or creditor(s) generally cannot claim partnership assets.FLPs can help lower taxes on family estates
Certified Document Services (CDS) prepares legal documents for non-lawyers in their own legal actions. CDS offers no legal advice, recommendations, mediation or counseling under any circumstance. CDS are not Lawyers, are not employed by a Lawyer, cannot give any legal advice and our employees are not acting as your Attorney. CDS can give you general factual information pertaining to legal rights, procedures or options available to you in a legal matter when you are not represented by an attorney. CDS cannot give you specific advice, opinions or recommendations about your legal rights, remedies, defenses, or strategies.