A family limited partnership is an increasingly popular legal entity for family run businesses that offers numerous attractive estate planning benefits including protection of assets from creditors, reduction of estate and gift taxes, and a way to facilitate wealth transfer or business succession.

How It Works

As with other limited partnerships, only general partners operate a family limited partnership.While limited partners can have primary ownership of partnership assets, they have no voice in operating the business.As general partners, parents can move assets out of their estate and into the ownership of their children; the limited partners, without turning over operational control.The income and deductions of the partnership are taken on each partner's personal tax return.

Tax Implications

Often parents begin as both the general and limited partners and then gift their limited partnership interests to their heirs.By turning over partnership interests over time, maximum leverage of the annual gift tax exclusion can be taken.

The benefit of a limited partnership is that all appreciating assets can be removed from the parents' estate saving their heirs a substantial amount in estate taxes.There also is an immediate benefit via a business valuation discount allowed by the IRS depending on the liquidity of the asset in question.This tax discount is granted because the value of the limited partnership interest is less than the market value of the assets, since the assets are not under the limited partner's control.

Asset Protection

A creditor can get a charging order for the assets of a limited partner, but because assets are held within the confines of the partnership, they are still controlled by the general partner.It is the general partners who decide whether to distribute cash to the limited partners, however, the limited partners carry the greatest tax burden based on their percentage of ownership.Essentially the creditor would likely get hit with a big tax bill, but not receive any income from the partnership.This scenario would highly encourage a settlement.It is important to note that not all states provide the same level of asset protection for limited partners.

IRS Scrutiny

Family limited partnerships, and in particular excessively high valuation discounts, have been receiving increased IRS scrutiny in an attempt to weed out those trying to take advantage of the benefits.New tax laws allow the IRS to ignore certain discounts for gift tax and estate tax purposes if the family can dissolve the partnerships immediately following asset transfer.When creating the family limited partnership, business formalities should be carefully observed and state laws regarding these types of partnerships should be strictly followed.Consult with professional counsel regarding the creating and maintenance of a family limited partnership.

Family Limited Liability Companies

A family limited liability company is a similar method of wealth protection.In this arrangement all partners have limited liability ownership and all members can have management rights.Under this structure, all the partners are protected from creditors in the same way as with a limited partnership.

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