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Family Limited Partnerships Considerations for Estate Planning

Last update on: Aug 10 2020
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family limited partnerships are evolving, and people are finding more uses for them. Until recently, family limited partnerships (FLPs) were considered primarily vehicles for reducing estate and gift taxes. But these vehicles are so flexible that families are finding many practical uses for them, even when taxes aren’t an issue. You might find that — if included in your Estate Planning strategy — they can keep your family together and help its wealth grow faster.

Estate planning professionals first became attracted to FLPs because they could generate estate and gift tax discounts. In the standard estate planning strategy, a couple forms an FLP, naming themselves as general partners. Property – such as cash, a business, or real estate – is transferred to the FLP in exchange for the limited partnership interests. The couple then can transfer the limited partnership interests to their children and grandchildren, either all at once or over the years.

As general partners, the parents control how the assets are managed. Because of that, and because none of the limited partners will have more than 50% of the vote, the limited partnership interests are valued at a discount. This “control discount” means the interests are worth less than a pro rata share of the FLP’s underlying asset value. Since the FLP interests are not publicly-traded and could take years to sell, a “liquidity discount” also is applied.

Together the discounts could reduce the value of the limited partnership interests by 20% to 40%. That means the parents can give a child a 20% interest in an FLP interest that has $1,000,000 in assets but pay gift taxes on only $160,000 to $120,000 of value instead of $200,000.

But FLPs have more than tax advantages. You might even want to use them when there are no tax advantages.

The greatest risk to family wealth probably is not taxes. More often, family wealth is lost because those who inherit it don’t know how to manage it. Forming an FLP now is a great estate planning strategy for all the family members to learn how to manage wealth and to work together.

The grandparents can put in all the money to start, or each child and grandchild can contribute cash to the FLP. As general partners the parents can set the agenda and have ultimate control over what is done with the assets. The FLP can be used as a great way to educate the younger generations and encourage them to think more about investing and managing wealth.  They can learn how different investments fit together, how assets are selected, and how to make decisions regarding the assets. Eventually, the younger generations should be able to make good decisions on their own.

The FLP also gives the family a reason to come together regularly and ensures they have something in common. This can be important when family members develop different interests and live in different parts of the country.

You can get other benefits from an FLP. By pooling a family’s wealth, or at least a portion of it, you might get lower investment fees. Most investment managers reduce the percentage fee they charge for larger accounts. Many investment accounts also have high minimum investment requirements. By pooling funds, the family might qualify for accounts that not all members could get into individually.

An FLP is more flexible than a trust. As general partners, the parents control which assets are bought and sold, when cash is distributed, and other key issues. The family can manage the assets themselves or hire outside managers who are supervised by the partners. Limited partners can leave and go their own way by selling their interests to the partnership. Or the whole operation can be liquidated by a vote of the partners.

If you decide to set up an FLP as part of your estate planning strategy, carefully think through the operation. When one of your goals is for the younger generations to learn about wealth, be sure that partner meetings are educational. Set learning goals for each meeting. It is a good idea to have an outside adviser at each meeting to discuss some aspect of the partnership assets. Or prepare your own presentation on one or more topics. Set a goal of having the younger generations make presentations and recommendations over time. Many advisors believe an outside person, such as an attorney or investment adviser, should lead discussions so that there is more of a feeling of equality among the partners.

You’ll also want some key provisions in the FLP agreement and in the operations.

  • Goals and communication are important. The family should draft an investing plan together. Key features include goals and parameters for the estate planning portfolio, voting rights, how differences will be handled, and rules on how decisions will be made. If the partners cannot agree on these basic procedures, then the family probably cannot invest together.
  • Partners should receive regular reports on how the investments are doing. There also should be regular meetings, probably quarterly, with specific agendas.
  • The FLP should have a way for partners to leave. You don’t want to make it too easy for a partner to exit. Otherwise, someone will want to exit after every disagreement. But you don’t want to lock in a partner who cannot work with the others or who is unhappy with the direction of the FLP. For example, you might want to require notice of six months to one year before a partner can withdraw and take his share of the partnership.
  • The partners should have adequate assets outside the FLP. The FLP is supposed to be for long-term investing of family wealth. You’ll want a provision that lets partners get some cash for emergencies or special situations. But generally income for basic living expenses should come from outside the FLP. The only exception should be for taxes owed on partnership income and gains. These pass through to partners whether or not the cash is distributed. So the partnership should distribute enough cash to pay the taxes.
  • The grandparents usually are the general partners. Since the GPs have final control, it is important to have a succession plan in place. The plan should name the actual successors, so everyone knows them. That usually is better than a provision that requires the partners to agree on new general partners shortly after one or both grandparents have passed away.
  • Don’t try to set up an FLP on your own. An attorney should draft the documents and lead discussions to ensure all issues are being explored. It also is a good idea to have an investment adviser assist in the discussions about how the money will be invested.

Properly set up and managed, an FLP can teach the whole family more about money and make the whole family’s wealth last considerably longer.

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