What Is a Family Limited Partnership (FLP) – Pros & Cons

The U.S. could experience some rather drastic tax changes in the near future. For instance, if the so-called Buffett Rule passes, capital gains taxes would increase from 15% to 30% for those with incomes above $250,000 or  those with a $1 million in hard assets. Another looming tax hike are the Bush tax cuts that are set to expire in 2013, pushing rates up for many Americans.

While these two tax alterations are not set in stone, one sure thing to consider is that the estate tax will be returning to 55% (from the current rates of 35%), and the amount you can exclude from your estate for tax purposes will be reduced from $5.12 million to the 2003 rate of $1 million. When a valuable inheritance is rich in land but light in cash, paying more than half your inheritance is a greater burden, especially if you have to sell the property to pay the taxes.

If you are a business owner, you must plan ahead for any of these potential tax eventualities. The Buffett Rule may never transpire, but estate taxes will not go away, and there’s a good chance that the Bush tax cuts will expire or be altered.

But how do you plan for changes in the tax code that have not happened yet – or might not happen at all? It’s simple: Focus on financial instruments and entities that will allow you to protect your assets and mitigate changes in the tax code. If you have a business that involves family members, or a business or assets that you want to leave to your family, then one such entity is the family limited partnership (FLP).

What Is a Family Limited Partnership?

A family limited partnership is a partnership agreement that exists between family members who are actively involved in a trade or business. The partnership divides rights to income, appreciation, and control among the family members, according to the family’s overall objectives.

The family “business” does not actually have to be a business in the traditional sense – assets such as real estate or investments can also be in a FLP, as can the family farm, ranch, or real estate holdings. The nature of the FLP allows you to shift the value of assets to other members, thereby reducing the size of the estate for certain members.

A family, as defined for tax purposes, only includes a person’s spouse, children, ancestors (including parents), lineal descendants (grandchildren), and any other trusts established for the benefit of those people. So, for example, a newly married spouse could be part of the partnership, but not a second cousin.

The most common way of setting up an FLP is to create a general partnership first with limited partnership interests. The general partner (or partners) then gift the limited partnership interest to the children or other family members who are eligible. Whomever holds the general partner title maintains control over the enterprise or assets, but the limited partnership interest lets children or other eligible family memberships share in the ownership.

This is probably where the concept of not mixing family with business originated. Business interests are ripe for family conflict. So why would anyone create an FLP and risk family strife?

Prev1 of 5Next

Leave a Reply

Your email address will not be published. Required fields are marked *