Family Limited Partnerships
Family limited partnerships (FLPs) can play an important role in family estate planning. Many individuals, and the Internal Revenue Service, are of the erroneous opinion that FLPs are only transfer tax avoidance schemes. In the appropriate circumstances, however, FLPs serve significant business purposes of combining, growing, controlling, protecting, managing, protecting, and transferring family wealth. Indeed, the courts have held that estate planning for these purposes is itself a valid business purpose, and not merely a tax-motivated transaction.
Under present law, properly structured FLPs do offer an added benefit of discounted value of limited partnership interests when those interests are transferred from one generation of the family to another. The fundamental economics of discounted values are sound, and have been upheld time and time again by the courts. These discounts arise due to limited partnership interests generally representing minority ownership interests, being subject to limited ability to transfer the interests outside of the family, and lacking the ability to cause the partnership to make property distributions to those interests. Under these perfectly reasonable and normal restrictions, the transfer value of a limited partnership interest is less than that interest's proportionate share of the underlying partnership assets. Transfers of limited partnership interests, therefore, reduce the tax costs of moving those interests to other family members, typically in a lower generation that the transferor.
In view of present proposals to eliminate or significantly reduce transfer taxes, will FLPs continue to be an attractive family estate planning tool? The answer is a resounding, "Yes!" In fact, FLPs should become less costly under a reduced transfer tax system since IRS challenges of FLPs as tax-avoidance tools should substantially diminish. That will permit families to maximize the business purposes of these arrangements. The ultimate tax benefits after estate tax repeal or significant decrease will depend on the relationship between taxation of lifetime gifts versus transfers at death.
Family limited partnerships are complex and require careful planning to achieve their goals irrespective of tax considerations. Restrictions on family members who are limited partners can be an emotional and contentious issue within the family. Some family members (a daughter, for example) may become managing general partners while otherwise equally situated family members (other daughters and sons) may remain limited partners. A desire to maintain equal capital ownership in the partnership by all children, while permitting more personalized interests in partnership income and loss may be thwarted by an inartfully drafted partnership agreement. Transfer limitations in the event of death, divorce, incapacity, or special needs must be carefully planned and drafted with all of the partners understanding the reasons for those restrictions.
We have worked with our clients and their attorneys in structuring family limited partnerships that meet the family's long-term estate planning objectives while working to avoid the pitfalls that can arise. Ronnie taught the partnerships tax course in the graduate tax program at the University of North Texas and has served as an expert witness in tax and management issues of FLPs. We would welcome the opportunity to work with you and your family to determine if a family limited partnership is an appropriate vehicle to achieve a portion of your family estate planning goals.
©2008 Ronnie C. McClure, PhD, CPA