Family Limited Partnerships
A Family Limited Partnership is a way you can remove assets (like a family business, stocks, real estate or insurance) and any future appreciation on them from your taxable estate without giving up control. It is especially useful when real estate or a family business might otherwise have to be liquidated to pay estate taxes.
HOW IT WORKS
When you set up a Family Limited Partnership (FLP), you transfer the assets into the partnership in exchange for partnership shares. Your shares will consist of "General Partner" shares (usually a small percentage of the total shares) and "Limited Partner" shares.
You keep the general partner shares and, over time, gift some or all of the limited partner shares to your children, removing the value of the gifted partnership interests from your estate.
As the general partner, you have full control - you determine how the assets are managed, when income is distributed and how the partnership is run. It would be much like having voting stock (general partner shares) and non-voting stock (limited partner shares) in the same company; as long as you hold all of the general partner shares - "voting stock" - you retain control. Limited partner shares (some of your shares, and all of the shares you give to your children) are passive - they have no say in how the partnership is managed. Losses and profits are allocated among the partners, but no income is distributed unless you, as the general partner, decide to do so. Also, the Partnership Agreement can be written so that shares cannot be sold or transferred without your approval.
ASSET PROTECTION
Family Limited Partnerships are a good asset-protection tool. If a partner is sued for something that goes wrong in their personal life (traffic accident, for instance) it is virtually impossible for a creditor (the person who sued) to seize the partnership shares to pay off the judgment. Limited Partner shares can actually be a liability to the creditor, so the creditor doesn't want anything to do with them. The creditor can try to take the General Partner shares, but those shares will generally be a very small proportion of the ownership, perhaps 1%, so those shares can be transferred for fair value (sold) to other family members and the sale proceeds applied to the judgment. But the underlying assets - land, securities, business, etc. - remain free of the partner's personal liability.
"NURSING HOME COSTS WORRY ME."
What about protection from losing assets to the cost of catastrophic illness or a nursing home "spend down?" Even for smaller estates, this is a place where an FLP shines. The creation of the FLP and giving of limited shares in this context is usually quite different than in a larger estate, where tax avoidance is a major issue. In this "smaller estate with nursing home fears" context a person might give all of the limited shares away immediately, holding onto the controlling share until entering the nursing home. Then, perhaps, you give to a trusted family member - or even better, to a trust you create and define - the general partner share to manage the whole FLP during your disability. Since you can transfer the 1% general partner share to a person or a trust at a value of only about 1% of the whole FLP, any Medicaid disqualification period will be very short, typically no more than a month or two! But you were able to control the entire FLP right up to the date you had to enter the nursing home, and with an irrevocable trust you set up, "control it" even thereafter!
This is a very specialized area of the law, but if you are proactive and get proper counsel you can save virtually all of your estate for your family.
GIFTING ADVANTAGES
Because there is no market for the Limited Partner shares, their value is usually discounted. What would someone pay for minority shares in assets over which they would have no control? So you are able to transfer these assets to your children, removing them from your taxable estate, at a discounted value - still without losing control.
If you gift shares in increments of $12,000 per year per child, there is no gift tax. (Larger gifts can be applied to your $1,000,000 lifetime federal gift tax exemption.) Since you are making gifts based on current, discounted value - not the appreciated value when you die - this lets you, in effect, lower and "freeze" the value of your estate at the time the gifts are made. Yet your real estate or other underlying assets - the wealth you are transferring to your family - will still be the growing, prospering assets or business that you are used to.
COMPARED TO OTHER ENTITIES
A Family Limited Partnership (FLP) gives you more control than a corporation, in which even minority stockholders (either your children or their creditors) can have substantial voting rights and can force sales, distributions or even liquidations.
A Family Limited Liability Company (FLLC) is sometimes used in ways similar to the FLP. While theoretically the FLLC can offer opportunities similar to those offered by the FLP, there is little precedent in court decisions to support the use of the FLLC. FLPs, on the other hand, have been tried and proven effective in all of the significant ways that we use them as planning tools.
DO IT YOURSELF PLANNING?
A Family Limited Partnership is a very, very complex legal tool. Just as there are advantages to be gained by using them, there are serious pitfalls to be avoided. When an FLP is not established correctly and maintained with appropriate formalities, the advantages will be lost. Even worse, there are advantages that are turned into disadvantages. Instead of tax advantages, you can end up with tax penalties; instead of creditor advantages, you can make yourself an easier target; instead of maintaining control, you can jeopardize even the control you had!
A Family Limited Partnership is one area, among many, where the old adage is especially true: if you think hiring a professional is expensive, you should try hiring an amateur and see how much THAT costs! Yet when done properly, your investment in this planning will repay your family handsomely.
