FAMILY LIMITED PARTNERSHIPS
NOTICE!!!!

Assets transferred to a FLP included in individual's gross estate. In general, an individual's taxable gross estate includes property they transferred during their life if they retained the possession or enjoyment of the property, or the right to the income from the property, for life. Individuals typically transfer assets to family limited partnerships (FLPs) in the hopes of achieving large estate tax discounts for the assets. However, in a major victory for the IRS, the Third Circuit Court of Appeals held that assets transferred to a FLP were includable in an individual's gross estate because at the time of the transfer, an implied agreement existed that he would retain lifetime enjoyment and economic benefit of the assets. In reaching this result, the Court noted that the individual didn't retain sufficient assets to support him for the remainder of his life, as calculated at the time of the transfer. It also indicated that the individual's lack of control over the transferred property didn't defeat the inference of an implied agreement under the circumstances of the case. Therefore, it is critical that a family partnership be implemented and operated correctly. This remains a viable estate planning technique, as long as it is done properly.

 

How Does It Work?

 

A Family Limited Partnership ("FLP") is simply a limited partnership among members of a family. A limited partnership has both general partners (who run the partnership) and limited partners (who are passive investors). Under a traditional limited partnership, general partners have unlimited personal liability for partnership obligations, while limited partners have no liability beyond their capital contributions. In most instances, a family limited liability partnership is formed to avoid any personal liability. This is particularly true when rental property is contributed to the family partnership. Typically, the partnership is formed by the older generation family members (for the purpose of our discussion, the parents), who contribute assets to the partnership in return for general partnership units and limited partnership units. The parents can then embark on a plan of giving limited partnership units to their children and grandchildren, while retaining the general partnership units that control the partnership.

 

Most any type of property can be contributed to an FLP. For example, FLPs have been formed to hold family compounds, businesses, rental real property, and in some cases marketable securities. The founding general partner's principal residence or automobiles should not be used.

 

The partnership agreement will govern how partnership income is divided among the partners. Generally, both general and limited partners share income and cash flow based on their percentage interest in the partnership. It is important to realize that although income tax liability passes through to partners automatically, cash is not distributed to partners until the general partners determine to make a distribution, In this way, the general partners retain control over the assets in the FLP, whereas limited partners are granted very limited rights. Limited partners also have restrictions on their ability to transfer their partnership units to others, so that the general partners can prevent the units from being transferred outside of the family.

 

The Benefits Are Significant

 

There are many tax and non-tax benefits to FLPs. However, we do not recommend this concept for a contribution of assets worth less than $1,000,000. Important benefits include:

 

 

 

Transfer Tax Benefits

The principal benefit of an FLP is its significant impact in reducing a transferor's gift and estate tax. By using an FLP, The owner can take advantage of gift and estate tax valuation rules relating to "minority interests" and "marketability" that can reduce transfer taxes. Due to the significant restrictions imposed on the limited partnership units, the partnership units typically will have a value that is approximately 45 percent less than the value of the assets that originally were transferred to the partnership. (actual discounts can range from 35% to 70%).

 

For example, if the parents in a family transferred $1,000,000 in assets to a family limited partnership, and transferred limited partnership units representing 90% of the partnership interests, those units would be valued at approximately $495,000, compared with the $900,000 value of the underlying partnership assets associated with those limited partnership units. Thus, when the parents transfer the limited partnership units to the younger generations, their transfer taxes will be significantly lower than if they had transferred the partnership assets directly to the younger family members.

 

Once the FLP has been established and funded, limited partnership units may be given to younger family members by means of an annual program taking advantage of the $11,000 gift tax exclusion. Parents may make tax-free gifts of limited partnership units with a value of $11,000 ($22,000 if married) to each child or grandchild each year. The discounts described above will be used in determining the value of these gifts, removing the property from the parents' estate at a lower value. In addition, the future appreciation in the value of the limited partnership units will be excluded from the donor's gross estate for estate tax purposes, Over time, a series of gifts of partnership units made in this manner can result in large transfer-tax savings.

 

The parents may also choose to transfer a larger block of limited partnership units, taking advantage of the transfer tax applicable exemption. For tax years beginning in 2002, this exemption permits each parent to give a cumulative amount of $1,000,000 to anyone without incurring federal gift tax. A large gift of limited partnership units discounted in value may be made in addition to annual exclusion gifts. Such a gift may be recommended when significant future appreciation is anticipated, because it will remove a greater portion of the assets from the parents' estates before the assets increase in value.

 

If the parents die while still holding partnership units (either general or limited ), the estate tax value of the partnership units may also be reduced by discounts (1) for lack of marketability, (2) as a general partner, for potential liability of the general partner to the limited partner, and (3) if appropriate, because it represents a minority interest. This could also result in reduced estate taxes.

 

Income-Tax Benefits

 

The primary income tax benefit produced by an FLP results from shifting income between different taxpayers by means of gifts of limited partnership units. If all tax law requirements are met, each partner is liable for tax on his or her distributive share of partnership income, whether or not that income is distributed. Over several years, the allocation of taxable income to family members in lower tax brackets can substantially reduce overall family income taxes.

 

Careful Planning Is Essential

 

Using an FLP in one's estate planning requires careful analysis and strict compliance with IRS requirements, as well as professional assistance.

 

If the transferred property includes real property, art work or a business, the transferor must obtain an appraisal to establish the value of the property. It is also essential to have a qualified appraisal to establish the discounted value of the partnership interests.