Family Limited Partnerships – A family limited partnership, or FLP, is a business or holding company owned by two or more family members. Family, as defined for tax purposes, includes a spouse, children, parents and such lineal descendants as grandchildren.
Each family member can buy shares in the venture for a potential profit.
FLPs have two types of partners:
- General partners usually own the largest share of the business.
- They’re responsible for day-to-day management tasks, such as overseeing all cash deposits and investment transactions.
- General partners may take a management fee from profits if that’s part of the agreement.
- Limited partners have no management responsibilities. They buy shares of the business in exchange for the dividends, interest and profits that the FLP may generate.
The nature of FLPs varies depending on the business. Say you want to start a luxury apartment venture. You can call some family members and establish an FLP, issuing limited partnership shares that state that units cannot be sold for at least six years and that the FLP will pay earnings in the form of dividends. As the mortgage is paid off, profits and dividends are distributed, and each family member profits.
FLPs pass down wealth to younger generations, securing tax protections. A particularly advantageous way to pass them on is to do it during your lifetime, as gifts. Every year, FLP interests can be bestowed as gifts tax free to other family members, up to the annual gift tax exclusion. These assets effectively leave the original owner’s estate as far as the IRS is concerned. Future returns on the shares would be excluded from the giver’s estate taxes. Their children and grandchildren would benefit from any interest, dividends or profits generated from the FLP — thereby preserving wealth for future generations.
Stipulations can be set to protect shares from being squandered or mismanaged. For example, they can stipulate that gifted shares can’t be transferred or sold until beneficiaries reach a certain age. If beneficiaries are minors, the shares can be transferred through a Unified Transfers to Minors Act or UTMA account.
FLPs have limitations:
- The FLP must be run as a business, exposing general partners to potential liability.
- The FLP remains susceptible to any claims by creditors of its general partners.
- The general partners must be competent to run the FLP as a business.
- Personal assets can’t be transferred into an FLP without endangering your use of the annual gift tax exclusion. This means an FLP is only advantageous if you have sufficient nonpersonal assets — investment properties and securities — to be transferred to the FLP.
- Children may be exposed to major capital gains liabilities. Gifted property doesn’t receive the stepped-up basis treatment that bequeathed property receives.
- If the FLP is created for real estate or investment securities, then you could find the FLP to be considered an investment company. This may cause capital gains and losses realized on the transfer of property into the partnership.
Setting up an FLP can cost anywhere between $5,000 to $10,000, with ongoing costs after setup. The structure of FLPs and the tax laws governing them are complex. Families should consult qualified accountants and tax professionals when they are thinking of establishing an FLP.
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