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Should a Family Limited Partnership Be Part of Your Estate Plan?

Should a Family Limited Partnership Be Part of Your Estate Plan?

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Family limited partnerships (FLPs), legal devices used to move wealth from one generation to the next while minimizing tax exposure, are a critical part of any estate plan. FLPs pool a family’s money to execute a business venture. The FLP has two types of partners: general and limited. The general partners manage the assets of the FLP while the limited partners possess equity interest but are unable to engage in the day-to-day management of the assets. However, in exchange for reduced involvement, limited partners have limited liability for the company’s actions and debts.

Establishing FLPs

The structure of FLPs varies depending on the business purpose but, in general, parents will pool their resources in the partnership and serve as the general partners. For example, if a family member wants to erect an apartment complex but lacks the funds to finance the venture, she might solicit investments from family members. She then allocates shares based on the contributions to the family members.

Tax Benefits

FLPs are useful in transferring wealth because individuals can gift up to $15,000 in FLP interests per year tax-free (for couples, it can be $30,000). So, parents who have $2 million in savings and three children who are all married can gift $30,000 in FLP equity interests to each child and their spouse amounting to $120,000 per year – tax-free. Once these shares are gifted, they are no longer part of the parent’s estate and are not touched by the estate tax. Moreover, future dividend earnings from those shares are not attributed to the children. Finally, FLPs allow parents to control how much money is disbursed and under what conditions. FLPs can include provisions that restrict the sale or transfer of shares in the FLP.

Possible Tax Issues

Several issues can arise if the Internal Revenue Service audits the FLP. First, the IRS can disallow the transfers if it finds that they were done for a fraudulent purpose. FLPs which establish a legitimate business purpose survive IRS audits.

Second, the IRS can challenge the valuations of the shares. The IRS can and does re-value business shares if it determines the valuation was overstated. Accidental over-valuations do occur because valuing business shares is complex and often requires the input of accountants and lawyers.

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