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The Greatest of All Time: “The Family Limited Partnership”

By Matt Dana

By, Matthew S. Dana, JD, CPA, CLU, LLM

Over my 34-year career in limiting my practice to Estate Planning, many have asked me what I consider to be “the best” Estate Planning tool. Most people would expect me to say something along the lines of a Last Will and Testament, or perhaps the prolific Revocable Living Trust. Although I would admit that those two tools are perhaps the most common Estate Planning tools, they are not “the best”. Over the past 15 to 20 years I have publicly stated that in my professional opinion “the greatest” Estate Planning tool is the Family Limited Partnership (FLP).

So, with that said, maybe it is time to define what legal attributes of the FLP would lead me to say that it is the best Estate Planning tool. It certainly isn’t the most common. The most important legal attributes of the FLP, which will be briefly discussed in this article, will center around its benefits from an Estate Tax standpoint, an Income Tax standpoint, and an Asset Protection standpoint. So when I label it as “the greatest” I am considering the economic benefit of this tool to the family in saving taxes and protecting family wealth. In my opinion, the amount of money that this single tool can save a family leads me to label the FLP as the GOAT (“Greatest of All Time”). It is the Tom Brady or the Michael Jordan of the Estate Planning world.

Estate Tax Savings Benefits of the FLP

Let’s first discuss the Estate Tax savings benefits of the FLP. First, the FLP is the only entity that I am aware of where control of the entity can be separated from the value of the entity. For example, with a Corporation, one would have to retain a 51% majority of the entity to keep control. This limits the ability of the client to give away only a 49% interest yet maintain control. In an FLP, a client can keep only a 1% voting interest yet maintain control over the entire partnership. To put it another way, the client can give away 99% of the equity of an FLP yet maintain control. Giving up control of an entity is probably the most singular drawback that a client would have to reduce his or her estate by gifting assets to other family members. With an FLP, clients are more willing to make a sizable gift of the Partnership to his or her children or grandchildren.

The second most important feature of an FLP is the ability to “discount” the value of a Partnership Unit. In a nutshell, the IRS recognizes a 30% discount (national average) in valuing a Limited Partnership Interest when it is gifted to junior family members. When creating an FLP, two classes of Partnership Interests are created as described above: Limited Partnership Interests (non-voting) and General Partnership Interests (voting). When the senior family member makes a gift, he or she will gift the Limited Partnership Interests, the non-voting interest, and maintain the voting Partnership Interest. Through years of court cases and IRS regulations, the Internal Revenue Service has been forced to recognize that a non-voting interest does not have the same value as a voting interest. This is commonly referred to as a “minority discount”. In addition, since a Limited Partnership Interest is not traded on an open market, there is also a “lack of marketability discount”. These two discounts generally are added together to achieve approximately a 30% discount. As an example, if an FLP had underlying assets of $1 million, a 70% Limited Partnership Interest would not be valued at $700,000. Instead, a 30% discount would be applied to the value of the Limited Partnership Interest and would be reported to the IRS in a Gift Tax Return at $490,000. Essentially, $210,000 in value disappears. That is a powerful Estate Planning tool. The entire Estate Tax system is based upon Fair Market Value, the value that a willing buyer and a willing seller would agree on. And, the reality of the transaction is that a willing buyer would not pay full value for non-voting units that are not marketable.

Control Through the 1% Voting Interest

In the most general terms, a client can create an FLP with $1 million worth of assets, give away 99% of the value of the FLP yet retain control over the entire Partnership. And to make it even better, the value of the gift to the junior family members can be discounted by almost $400,000. Of course, this explanation is an overly simplified explanation of a complex topic. But it illustrates the value of “discounts”.

With the 1% voting interest, the General Partnership Interest, what can the client control:

  • All of the investment decisions of the Partnership. What assets will be sold, and what the proceeds will be re-invested in.
  • All distributions of the profits – the client controls the timing and amount of distributions.
  • The management of the Partnership – the client has control over the day-to-day management and operations.

Income Tax Benefits of the FLP

Now let’s turn to the Income Tax benefits. For an FLP to qualify for the aforementioned discounts, the IRS requires that the FLP be operated for a legitimate business purpose. However, the term “legitimate business purpose” is broadly defined. One such purpose may be to own and manage investment property, which is a common use of FLPs. The FLP provides a tax-efficient way to manage and distribute income among family members. Since the FLP is a pass-through entity for tax purposes, the income is reported on the individual tax returns of the partners, avoiding double taxation.

Additionally, the FLP allows for flexible allocation of income and expenses. The General Partner can allocate income and deductions in a manner that is most advantageous for tax purposes. For instance, if one family member is in a higher tax bracket, the FLP can allocate more income to family members in lower tax brackets. This can result in substantial tax savings for the family.

Asset Protection Benefits of the FLP

The Asset Protection benefits of the FLP are also significant. Because the FLP is structured to separate control from ownership, it can provide a layer of protection against creditors. The Limited Partners (those who do not have control) are generally not personally liable for the debts and obligations of the FLP. This means that if a Limited Partner faces a lawsuit or financial trouble, the assets within the FLP are typically protected from personal creditors.

Furthermore, the FLP structure can help protect family assets from future claims. By transferring assets into the FLP, those assets are generally shielded from potential claims against individual family members. This can be particularly valuable for families who own significant assets or operate businesses that may be subject to legal or financial risks.

In Summary: The Power of Family Limited Partnerships

In summary, the Family Limited Partnership is an incredibly powerful Estate Planning tool due to its unique benefits in Estate Tax savings, Income Tax management, and Asset Protection. By leveraging the FLP, families can effectively manage their wealth, reduce tax liabilities, and protect their assets from potential risks. While it may not be the most common Estate Planning tool, its advantages make it a compelling choice for those looking to maximize their Estate Planning strategy.

If you are considering implementing a Family Limited Partnership or need personalized guidance on Estate Planning, contact Dana Whiting Law. Our experienced team is here to help you navigate the complexities of Estate Planning and ensure that your family’s financial future is secure. Reach out to us today to schedule a consultation and learn more about how the FLP can benefit your estate plan.