18 May Benefits of a Family Limited Partnership

Q. About 20 years ago we opened a Family Limited Partnership account on the advice of our attorney. The account has grown a lot and we have not done anything with it. What would be the correct way to take advantage of this type of investment? Is it something to be used during our lifetime or after we pass on?
— Uneducated

A. Let’s talk first about exactly what a Family Limited Partnership (FLP) is and how it works.

Typically, parents establish the FLP and transfer assets that they feel have good growth potential, said Gerard Papetti, a certified financial planner and certified public accountant with U.S. Financial Services in Fairfield.

He said the general partner would have 1 percent and the other 99 percent would be held by limited partners.

“The general partner retains all control over FLP assets,” Papetti said. “Limited partners have the majority of ownership but no control over FLP assets and FLP management decisions.”

Parents would transfer limited partnership interests, usually by gift, to children, grandchildren or a family trust, he said, and the valuation of the gift can be discounted for “lack of control” and “lack of marketability.”

Papetti said the FLP can provide many non-tax, income tax and estate tax benefits.

On the non-tax side, the FLP can allow for the management of family investments such as real estate and marketable securities, Papetti said. It would have a successor management plan to allow continuity of the control and management of the FLP assets.

On the tax side, Papetti said, it gives you the ability to divert taxable income to family members with lower tax brackets.

It also gives you the ability to transfer wealth to other family members or a family trust by use of the annual gift tax exclusion of $14,000 per donee or use of the owner’s lifetime federal gift tax exemption, which is currently $5.45 million, Papetti said.

“Note the state of New Jersey does not have a gift tax so you can make unlimited gifts during life, however gifts in excess of the annual tax exclusion made within three years from the date of death are included in the decedent’s New Jersey taxable estate,” he said.

The FLP also allows you to discount the value of the gift of FLP interest for both a lack of marketability as well as lack of control, Papetti said.

“The IRS as well as the tax court has recognized that the transfer of a minority interest in a partnership is valued at a discount from the fair market value of its assets as the person receiving the FLP interest does not have control over the FLP management and due to the lack of control, has less marketability,” Papetti said. “The percentage of discount is what usually is challenged by the IRS.”

If the FLP was established as part of a wealth transfer strategy, Papetti said, the fact that it has grown should mean that the growth will not be included in the estate of the person(s) who created and transferred assets to the FLP.

“The FLP assets and any income earned can be used to make distributions to the partners,” he said. “Partners usually include the children, grandchildren or a family trust. Distributions can be used by the partners to help purchase a home, fund children’s or grandchildren’s education, or just supplement their income.”

Papetti said FLP assets can be used during the lifetimes of the partners or to maximize the wealth for the next generation. It depends on the objective of the general partners.

A Family Limited Liability Company (FLLC) can accomplish the same benefits as a FLP, Papetti said.

So exactly how you want to take advantage of your FLP will depend on your goals and the goals of your family members. You should speak to a financial advisor or attorney who can examine the specifics of your situation before you make any decisions.

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This post was first published in May 2016.