Once an obscure tax loophole, the Family Limited Partnership (FLP) has become an increasingly popular entity structure. Properly structured, an FLP can be used to shift income tax burdens from parents to children as an estate-planning tool. Yet, those who approach it with a "set it and forget it" attitude open themselves to IRS scrutiny and significant estate tax exposure.
Making an FLP Work
An FLP is simply a limited partnership among members of a family. Typically, the partnership is formed by the older generation, which contributes assets to the partnership. Parents then give limited partnership units to their children and grandchildren, while retaining the controlling general partnership units. Both sets of partners — general and limited — share income based on their percentage interest. By including their children as partners and sharing partnership income with them, parents will find that total family taxes may be reduced because the children, as limited partners, are partial owners.
Of course, there are both pros and cons to this strategy.
Pro: Tiered Discounts. Valuation discounts based on lack of control, marketability and liquidity of the ownership units can be used to reduce the value of an estate. These discounts are based on the principle that the sum of the FLP interests is less than the value of the underlying assets held by the entity.
Pro: Asset Protection. An FLP provides formidable asset protection for the younger generation of shareholders. Hostile creditors must first obtain a charging order to obtain benefits from the attachment of a limited partner's interest. However, the general partner of the FLP (typically, an adult family member) still has unlimited exposure (other than assets exempt under the bankruptcy provisions).
Con: IRS Scrutiny. The IRS maintains a well-publicized negative stance on FLPs. That's the bad news. The good news is that there are steps you can take to avoid unwanted scrutiny.
Passing the Smell Test
To avoid trouble, all the holdings of the FLP should be for business or investment purposes, and all payments made by the FLP should facilitate those purposes. For instance, the family residence should not be placed into an FLP, nor should normal family expenses (e.g., educational expenses) be paid from the FLP. If the family requires money from the FLP, it should either be borrowed from the FLP at current interest rates or distributed from the FLP to the various trusts holding the interests, and from there given to family members.
In the end, professional assistance from a competent attorney and CPA is critical to successful FLP planning, implementation and maintenance.
CNB as a matter of practice does not provide tax or legal advice. It is recommended that you seek the advice of professional tax and legal advisors prior to establishing partnerships.
|City National Bank, as a matter of policy, does not give tax, accounting, regulatory or legal advice. The effectiveness of the strategies presented in this document will depend on the unique characteristics of your situation and on a number of complex factors. Rules and Regulations in the areas of law, tax and accounting are subject to change and open to varying interpretations. The strategies presented in this document were not intended to be used, and cannot be used, for the purpose of avoiding any tax penalties that may be imposed. The strategies were not written to support the promotion or marketing to another person of any transaction or matter addressed. Before implementation, you should consult your own advisors on the tax, accounting and legal implications of the proposed strategies based on your particular circumstances.|