The Family Limited Partnership

Tax and nontax benefits are substantial, but so is the downside.

Many people have heard of the Family Limited Partnership, otherwise known as FLP. The amazing thing is, the terms Family Limited Partnership and FLP do not appear in the Internal Revenue Code or any of the accompanying regulations. It’s important to know the pluses and minuses of the FLP when doing estate planning.

While the tax benefits of the FLP are substantial, the nontax benefits cannot be overlooked:

  • Consolidation of management is a benefit of the FLP structure. Instead of setting up separate trusts, separate bank accounts and separate brokerage accounts, the FLP can use one central account.
  • The FLP also provides the benefit of creditor protection. Assets involved in businesses, especially a closely held business owned by a minority non-voting shareholder, are often not attractive to creditors or potential ex-spouses.
  • A professional business appraiser is required to be retained when valuing an FLP. The appraiser will appraise the business using a variety of methods, methods that may be advantageous to your estate tax position.
  • It follows such that along with an appraisal, the professional appraiser can assign discounts for lack of marketability and lack of control. For an FLP, combined discounts for lack of control and marketability can total from 20-40 percent.

Along with the advantages, there is a substantial downside. That downside is a substantial list of ways to derail the intent of the FLP and the advantages it sets forth:

  • Many promoters of the FLP actively encourage people to insert nearly all of their personal property into the FLP. Including all personal property in the FLP is the worst possible thing that could be done. The IRS sees right through it, brings it to court, and oftentimes wins easily.
  • Corporate structures, such as corporations, LLCs and S Corporations, all have requirements on their formalities. It is nearly universal that those holding a corporation or FLP will not exactly follow the procedure necessary to uphold the use of the corporate entity or its like. It is with this that many FLPs fail and leave the owner with a large tax bill.
  • Forming the Entity but placing nothing in it is another common folly. Many individuals go to great lengths and expenses to form an FLP, and they form very proper, well-utilized entities. The downfall is that sometimes they do not place sufficient assets in the FLP.
  • Failing to maintain the FLP can also mean the downfall of the entity. Each state has a mandatory fee for every entity registered within its borders. If this fee is not paid, eventually the entity is administratively and involuntarily dissolved. The result, no FLP benefits.
  • In any legal or tax strategy, it pays to know the jurisdiction. From a legal perspective, bankruptcy laws differ, as some states offer only a charging order to creditors trying to collect from Limited Partnerships. A charging order is a less preferred method of collection to the creditor. If states do not allow charging orders, this is less favorable for an FLP.

While the Family Limited Partnership has its place for certain individuals, most people will benefit from other or additional estate planning. The fact is that only 25 percent of those doing estate planning should have an FLP. Trusts, business planning and a host of other instruments are available to properly plan the actions and courses to be taken when the time comes.

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Bart Basi Bart A. Basi, Ph. D. (left) is president of the Center for Financial, Legal & Tax Planning, Inc. Marcus S. Renwick is director of research and publications with the firm, located in Marion, Illinois, and on the Web at taxplanning.com. Marcus Renwick