A business partnership, of which there are several types, is an attractive option for many business owners who know others who share their entrepreneurial visions. There are two main types of business partners — general and limited. General partners have voting rights regarding the direction of the company and are typically charged with managing the day-to-day of the partnership while limited partners do not enjoy control of the business. Limited partners’ finances are typically shielded from judgments having to do with the company in exchange for the loss of power over the company.
For those seeking to use a tax-efficient structure to pass along certain assets to the next generation, a Family Limited Partnership (FLP) could be useful. This legal structure is, essentially, a limited partnership that requires partners to be family members. However, it has some functions similar to a trust that make it advantageous for estate planning.
How an FLP Works
Often, the original partners in an FLP are married couples wishing to someday pass the partnership on to their children. A limited partner in a family limited partnership may also be a general partner. The difference is the amount of interest each partner owns. For example, the general partner could own one percent of the FLP while the other legal partner (who can also be both a general and limited partner) also owns one percent as a general partner. The remaining 98 percent is owned by limited partners.
While there may be difficulties in accomplishing this upon forming a partnership, the reason for an ownership structure such as this is that the assets owned by the limited partner cannot be used for judgments against the partners as individuals because the FLP is legally recognized as the owner. A limited liability company (LLC) can also serve as a sole general partner to further shield partners from liability.
If the general partners own a more substantial interest in the partnership, over time the general partners can transfer assets owned by the FLP, through gifting or otherwise, to other limited partners (such as children). This is advantageous because if a partner gifts, for example, 5% ownership of a $1 million partnership to another partner, the total gift can be valued at less than $50,000 (5% of $1 million). This can be accomplished by utilizing valuation discounts and can substantially decrease the taxable estate of a partner over time.
General partners can also make large distributions that could otherwise trigger gift and estate taxes. However, the unique structure of the FLP allows those receiving the distributions to avoid these taxes.
Another benefit of FLPs is allowing the next generation time to ease into general partnership and management roles while enjoying the full value of the business. Limited partnership ownership gifted to others (such as family members) also decreases the taxable estate for the gifting partners, as indicated above.
Conclusion
There is plenty of room for entrepreneurs to get creative when setting up the legal structure for their businesses. Depending on what your goals are, you can have something that reduces your personal liability, avoids double taxation, and even achieves certain estate planning goals.
Family limited partnerships can serve several functions for closely held businesses. If you’re looking for a way to pass along your business to your heirs in a tax-efficient way, our firm would love to help. Attorney Tyler Q. Dahl is one of fewer than 100 attorneys in the U.S. who is also a Certified Tax Coach. Call our firm at (916) 545 – 2790 to discuss your options with our legal team today.
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