What You’ll Learn: Gain an understanding of what exactly a family limited partnership (FLP) is, its benefits, and when you might need to consider one. You’ll also learn how it compares to trusts and LLCs— and how to get started if it’s right for you.
A family limited partnership (FLP) is a legal setup in which two or more members of the same family plan their estate by pooling their assets. The main goals of an FLP are to facilitate smooth wealth transfer among family members, minimize estate taxes, and protect family assets from creditors or lawsuits. In simpler terms, it is a company or business under ownership by at least two family members.
To understand how an FLP works, it’s helpful to first examine its unique structure, which splits roles and responsibilities to balance control and benefits across family members. We’ll delve deeper into the structure and benefits below. We’ll also compare FLPs to trusts and LLCs. In addition, we’ll highlight the pros and cons to help you decide whether setting up an FLP will be worth your while. Finally, you’ll learn how to set up an FLP should it be right for you.
Understanding the Family Limited Ownership Structure
An FLP has two types of partners—general partners and limited partners. The former are usually the parents in a family. The latter are typically their children, who own shares of an FLP but have no control, enjoying limited liability.
Let’s take the case of a hypothetical married couple, Jane and John, owning a rental property portfolio forming an FLP. They are general partners and, as such, control leasing and sales. Their children receive income from the rent their parents collect.
To lower their taxable assets while retaining total control over their estate, Jane and John may choose to give their children partnership stakes. In this scenario, the legally enforceable partnership agreement establishes the rules governing the transfer of ownership stakes, outlines responsibilities, and specifies how profits will be divided.
This structure is the foundation of an FLP’s estate planning power, blending control with transferring wealth.
Family Limited Partnership in Estate Planning: Key Benefits
Family limited partnerships are popular when it comes to estate planning because they offer a slew of wealth preservation advantages. Here are the five main advantages that make FLPs a beneficial option for families.
1. Asset Protection
Assets held in an FLP are, by law, protected from lawsuits and auctioning by creditors of individual family members. However, this does not apply to creditors of the FLP. This kind of protection ensures that even the creditors of the FLP are only granted access to distributions rather than actual assets.
2. Tax Benefits
An FLP will come with valuation discounts of between 20% and 40% on limited partnership interests because of their lack of control and marketability. As a result, gift and estate taxes will be reduced significantly. For instance, a $100,000 asset might be valued at $60,000 for tax purposes. This is a smart way to lower your tax burden when transferring wealth.
3. Wealth Transfer
In an FLP setup, interests gifted to heirs reduce the general partners’ taxable estate. As such, families can pass down wealth gradually while keeping estate taxes low. You can strategically leverage annual gift tax exclusions for this purpose. This way, you can efficiently shrink your taxable income over time.
4. Control Retention
General partners in an FLP setup still retain authority over assets, even after gifting the ownership to family members. They may still make critical decisions on sales, investment, and distribution without any limitations. As such, the family’s financial strategy and vision can remain intact. This kind of arrangement may be a good option for family members who want to give but not cede total control.
5. Family Unity
Family members can collaboratively work on shared financial goals in the environment created by FLPs. Limited partners benefit from the income generated by the same assets managed by general partners. This type of arrangement promotes intergenerational cooperation and communication while keeping families financially connected.
Family Limited Partnership vs. Trust: What’s the Difference?
A trust is a formal arrangement in which you provide assets to a trustee, who then administers them for your beneficiaries following guidelines you establish.
There are two main types:
- Revocable trust: You maintain control and are free to alter or terminate it at any moment.
- Irrevocable trust: You cede authority in exchange for improved asset protection and possible estate tax advantages.
FLPs and trusts are two essential tools for safeguarding your wealth and ensuring a smooth transition of ownership. However, because they are designed for different tasks, choosing the best one will depend on your goals.
1. Control
FLPs are a beneficial option for those who want to maintain control of their wealth. As the general partner, you run the show while your kids (limited partners) get a slice of ownership, but zero say. For trusts, things are different. If you set up an irrevocable trust, the trustee—not you—manages everything based on the rules you set. Revocable trusts give more wiggle room but still offer less control than an FLP.
2. Tax Benefits
FLPs offer nice estate tax discounts thanks to valuation rules (your $100,000 asset might be worth $70,000 on paper). Trusts don’t offer discounts, but they can keep assets out of your estate entirely, hence no estate tax.
3. Asset Protection
FLPs protect family businesses or investment properties. Creditors can’t force a sale. They can, however, issue a charging order to collect a debt. Trusts work better for personal items like your home or savings. Trusts also guard against probate headaches.
4. Flexibility
Trusts win this round. They’re easier to set up, can be tailored to your exact wishes, and revocable ones can be changed at any time. With FLPs, however, once that partnership agreement is locked in, it’s more difficult to make changes.
Consider an FLP if you want control and tax perks. A trust might be the right option if you value simplicity and flexibility. You can also use both—one to hold your business, the other to hold your house.
Family Limited Partnership vs. LLC: Which Is Right for You?
A limited liability company (LLC) is a business structure that combines the pass-through taxation of a sole proprietorship or partnership with the limited liability of a corporation. This means that, in the event of insolvency or litigation, your personal assets are protected from creditors since they’re recognized as separate entities.
Let’s take an example of a person trying to pass down the family business or real estate empire. An LLC and an FLP are the two options available. Both aid in succession planning and asset protection, but the nuances are crucial.
1. Liability
In an FLP, general partners (usually the parents) are in control, but they’re also personally liable for debts. In an LLC, all members have limited liability, meaning no one’s coming for your personal bank account if the business tanks.
2. Control
In an FLP setup, general partners control everything; limited partners (like the kids) just wait for their inheritance. In an LLC, power is more evenly split based on ownership.
3. Taxes and Estate Planning
If you want estate tax perks, an FLP might be the right option. It’s designed to transfer wealth with less IRS involvement. LLCs don’t offer as much on the tax savings front, but they’re stronger at keeping creditors at bay.
Some people combine both—an LLC as the general partner of an FLP. This approach provides estate tax benefits and asset protection.
How to Get Started With a Family Limited Partnership
Here’s a step-by-step guide to help you set up your FLP correctly—from defining your goals to ensuring ongoing compliance.
1. Define Your FLP Objectives
Why are you doing this? Do you want to pass wealth to your kids without paying high taxes? Or maybe you’re pooling family cash for investments and want to keep liabilities at bay. Think about and write down your goals.
2. Register Your FLP With the State
Submit a Certificate of Limited Partnership to your state’s Secretary of State. Most states offer online forms that ask for information such as the FLP’s name, address, general partners, and registered agent. It’s straightforward, but make sure you don’t skip it.
3. Draft the FLP agreement
A partnership agreement spells out who owns what, how profits get split, and what happens if someone leaves. It’s like a family rulebook that helps keep everything in check. Get it in writing, even if it’s just you and your trusted sibling.
4. Fund the FLP With Assets
You must put assets in the FLP, like property, stocks, or business stakes. Once they’re in, they belong to the partnership.. Talk to a tax professional to avoid surprise tax bills when doing this.
5. Get an EIN
Think of an employer identification number (EIN) as your FLP’s Social Security number. It’s free from the IRS website and only takes a few minutes to request. You’ll need it for bank accounts and taxes, so don’t skip this step.
6. Stay on Top of Compliance
Once your FLP’s registered, keep it legal. File annual reports, renew your registered agent, and check for state taxes (like franchise fees). It’s helpful to involve a CPA when it comes to compliance.
7. Taxes and Record-Keeping
FLPs are pass-through, so profits hit your personal taxes. However, you still need to file a Form 1065 with the IRS. Taxes can be challenging, so it’s best to hire a professional for this aspect.
Disadvantages of a Family Limited Partnership
FLPs aren’t flawless. They come with several drawbacks that you should be aware of. Here are some of them:
- Potential IRS scrutiny: The IRS frequently audits FLPs, particularly when they involve personal-use assets or lack a clear business purpose.
- Associated costs: An FLP often entails legal fees and recurring accounting, which can quickly add up to thousands of dollars each year.
- Restrictions on ownership changes: Liquidity is limited since limited partners aren’t allowed to transfer or sell interests.
- Family conflicts: Not being on the same page over profits or asset control can lead to family tensions. It can even give rise to strained relationships in extreme cases.
- Complex setup and management: FLPs require detailed agreements, state registrations, ongoing tax returns, professional appraisals, and careful tax compliance. All of these can be stressful.
Is a Family Limited Partnership Right for You?
An FLP might be right for you if you come from a high-net-worth family with a variety of assets such as real estate, investments, or businesses. It can provide asset protection, some tax benefits, and smoothen wealth transfer. This is especially ideal when it comes to estate planning.
However, an FLP might not be ideal for everyone. It’s important to consider that they come with potential IRS scrutiny and unforeseen costs. They can also be tricky to manage due to the complex structure. If you value simplicity, a trust might be a better option. Also, an LLC might be the best option if active businesses are your primary asset.
There are plenty of choices when it comes to safeguarding your wealth. Consider the pros, cons, and different options and decide if a family limited partnership is right for you.
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