_ Keep It All in the Family with FLPs; Family Limited Partnership

Posted By: Debbie - 05/28/2011 08:09   

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The Family Limited Partnership, or FLP - pronounced "flip" - is designed to reduce the value of your estate for estate tax purposes while allowing you to maintain full control of the investments and assets inside the partnership.
 
FLPs are established much like traditional limited partnerships. There are two parties involved: the general partners, who control the trust, and limited partners who have a share in the profits (but no control). The general partners (often, you and/or a spouse) design the partnership to give limited partnership shares to family members. General partners control the operations of the FLP and make day-to-day investment decisions. They can also receive a percentage of the FLP's income in the form of a management fee.
 
Limited partners (your heirs) have an ownership interest in the FLP, but they have very limited control. They share in the income generated by the FLP, depending on how many shares they own. When the FLP is dissolved, a proportionate amount of FLP property will pass to each limited partner.
 
Setting Up a FLP
 
FLPs have come under increased IRS scrutiny in recent years, so you should work with a reputable estate planning attorney. With the attorney's assistance, you can place your assets within the FLP using your estate tax credit. For instance, a husband and wife can each transfer up to $2,000,000 ($4 million total) into the FLP and allocate those assets to the limited partnership side. They can then place a smaller amount (e.g. $12,000) in the FLP for the general partnership side. There are usually no taxes incurred when funding a FLP with your assets.
 
In the beginning, you and your spouse own both General Partner and Limited Partner shares. Over time, you gift to your heirs Limited Partner shares using your annual $12,000 gift exclusion. Don't worry about giving away too much of the shares. Based on current tax law, the General Partners may own as little as 1% of the FLP's assets and still retain control. That means you can still buy and sell assets, dispose of property, and declare any distributions of FLP shares.
 
Leverage Your Estate Tax Credit
 
FLPs allow you to pass on more than the maximum $2 million (in 2006; $4 million per couple) Unified Estate Tax Credit. A gift of $2 million in limited partnership assets often may appraised at a substantially lower dollar amount. That's because there is no "market" for LP shares - they lack control and cannot be sold to others. This lower appraisal is called "discounting" the value of LP shares. Avoid discounting the shares too aggressively, however - the IRS could take exception and invalidate your FLP.
 
Protection Against Creditors
 
Because of their lack of control, LP shares are most undesirable to creditors. Creditors will find it difficult to seize limited partner shares, since they are not publicly traded.
 
Creditors also don't want to pay tax on income they don't receive. If the partnership has earned income, but the general partner does not declare a distribution, each general and limited partner is required to report a proportionate share of the earned income on his or her personal tax return, without actually receiving any dollars with which to pay the tax.
 
Two More Advantages of FLPs
 
FLPs are considered an "intangible asset" - most likely, only the state of your domicile will be able to impose any inheritance tax on Partnership units. This is ideal for real estate investors owners who own property in several states.
 
FLPs can provide additional retirement income - as mentioned previously, FLPs can provide general partners with management fees. This fee reflects the work you do as the general partner to maintain the FLP as a working business, and is considered earned income.
 
Family Limited Partnerships involve significant costs and risks involved, and are not ideal for highly appreciated assets. FLPs must also be drafted by an experienced estate planning attorney, and have a tangible business intent. For this reason, we strongly urge you to consult with a professional with specific expertise in this area.
 
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_MSN Money: Family Limited Partnership FLP

Family Limited Partnership
 
The Basics
Protect your family with a partnership
 
Though the IRS is targeting abuses, the family limited partnership is a legitimate way to protect your assets. And it's not just for the rich anymore.
 
By Jeff Schnepper
MSN Money
 
In the past few years, the family limited partnership has been a focus of Internal Revenue Service efforts to curb abusive tax shelters. The IRS maintained that a family partnership wasn't real; it was a tax dodge.
 
The agency had suddenly realized that family limited partnerships, sometimes called FLIPs, aren't just for the rich anymore. It's a solid tax strategy that advocates a way to protect a family's assets, potentially cutting in half or more what's owed on an estate-tax bill -- assuming there are any estate taxes to worry about.
 
That prompted the IRS to send out a flurry of "advisory notices," telling people that the agency may invoke a section of the tax code that allows it to disregard FLIPs because of potential abuses.
 
My response to this? Hogwash. If you or your family members have created a FLIP or are considering one, don't let the chest-thumping get in your way. As long as your motivation is to protect your assets from creditors or manage your assets more effectively -- just as in any limited partnership -- you're starting out on solid ground.
 
To understand a FLIP, you have to understand the basic structure of any limited partnership. After all, a FLIP is merely a traditional limited partnership where all the partners are family members. Remove the family relationship, and a basic FLIP is a basic limited partnership.
 
All limited partnerships have one thing in common: They all are run by general partners only. Under the law of all 50 states, by definition, no limited partner has any vote or voice in the running of the partnership business. A general partner, who may own only 1% of the partnership assets, will control 100% of those assets.
 
In a family situation, the parents put their assets into the partnership. They start by being both the general partners and the limited partners. Then, under the most common and simplest form, they gift their limited partnership interests to their children. Let's see what they have really done . . .
 
First, even though the parents have given away the limited partnership interests, they, as the general partners, still retain full control over all the assets in the partnership. The limited partners (who become the general partners upon the death of both parents) own and have title to the limited partnership interests. But they have no voice in the management of the partnership. In effect, the parents have given up ownership of the assets but have retained control. This does several things with gift and estate taxes:
 
Except for the 1% retention, the assets are out of the parents' estates. A completed gift has been made to their children. A gift tax may be due on the value of the gift. The parents, however, can use their unified gift and estate tax credit to pay that tax. In 2009, this credit, between both parents, shelters the tax on as much as $7 million ($3.5 million x 2). It is scheduled to become unlimited in 2010. In 2011, it's scheduled to fall back to $1 million per parent -- unless Congress votes to extend it. My best guess is that Congress will make the $3.5 million credit permanent before the end of the year. (See "2010: The best year to die?")
 
Since the gift has been completed, all appreciation on the assets is out of the parents' estates. Assuming both parents are age 40 when the transfer is made, and that one lives another 40 years, we have excluded 40 years of appreciation from the parents' estates. Further assuming a $7 million transfer and a rate of appreciation of only 7.2% per year, $112 million has been excluded from the parents' estates, and they have saved approximately $45 million in estate taxes. (Assuming there is an estate tax.)
 
Where the IRS gets really annoyed
Even if the parents die immediately after making the transfer and even if there is no appreciation in the assets, there is an immediate and substantial transfer-tax saving. Stay with me on this -- it's complicated.
 
Remember that the parents gifted the limited partnership interests to their children, not the assets in the partnership itself. While the limited partners own the assets, they have no control over those assets. Because they have no control over those assets, the value of the limited partnership interests (the value of the gift) is less than the value of the assets transferred.
 
Look at it this way: If you can buy an asset for $1,000 and have complete control over that asset, it has to be worth more than a limited partnership interest where you have no control. The value of the limited partnership interest must be less than the market value of the asset because you don't control the money. All of the courts that have reviewed this, and even the IRS, agree that there must be a discount. The more liquid (meaning cash), the lower the discount. The IRS historically has allowed a discount of as much as 40%, depending on the assets transferred. That means that the parents can transfer up to $11.67 million in assets structured as limited partnership interests without paying any federal transfer taxes. (60% of $11.67 million is the $7 million credit exclusion for 2009.) That's $4.67 million more than they could without the limited partnership.
 
The IRS argues that this is unfair to those who are unaware of the law or who can't afford high-priced attorneys to draft partnership agreements for them. And anyone who's married and has an estate of less than $7 million in 2009 can, if his will is appropriately structured, pay no federal gift or estate taxes. The FLIP is a real tax benefit only if your estate is $7 million or more. If you have that kind of money, you can afford to pay for competent estate planning.
 
Lower tax brackets and asset protection
The IRS does have one legitimate concern. In some cases, taxpayers have tried to take outrageous discounts of as much as 90%. Unfortunately, some people try to cheat; that's why we have audits.
Also, since the children as limited partners own 99% of the partnership, 99% of the income will be taxed to them. This also has concerned the IRS. Traditionally, the parents will be in a higher income tax bracket than their children. If the parents are in the 35% bracket (the top rate for 2009) and the kids are in the 25% bracket, we have reduced the tax bite by 10 percentage points.
 
A FLIP also provides asset protection. Before the transfer, 100% of the parents' assets were subject to their creditors, now only 1% is exposed.
 
But what if the kids are sued? Well, against a limited partner, a creditor can get a judgment called a "charging order" only. This places the creditor in the same shoes as the limited partner. So if the partnership earns $100,000 and the limited partner owns 99%, the creditor is going to be taxed on $99,000. But as general partners, the parents decide whether to distribute any cash to the limited partners. So the creditors could then end up getting taxed on $99,000 in income every year, even though the general partners aren't giving them a single penny. This is a great motivator for creditors to settle.
 
The increase in the exclusion amount means that fewer taxpayers will have to use a FLIP to reduce their estate tax, at least until 2011. Few tax professionals believe that the unlimited exclusion will remain or that the reduction to $1 million in 2011 won't be changed. But in any case, FLIPs will still provide creditor protection and potential income tax reduction, regardless of what happens to the estate tax.
Family limited partnerships are legitimate wealth-preservation and asset-protection structures. Just because they are costing the government tax money doesn't make them bad. Remember, it's your money, not theirs.
 
Updated Dec. 2, 2009

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Tax and Legal Tips for LLCs and Corporations 
 
Introduction
Highlights
Choosing Between an LLC and a Corporation

Lowering the Tax Rate
The Tax Shelter Benefit
Avoiding the Personal Service Corporation Classification

Allowable Tax Deductions
Charitable Deductions
Health Insurance
Medical, Dental and Drug Expense Reimbursement Plan
Disability Insurance
Business Automobile
Business Insurance
Office at Home
Tangible Property (Section 179)
Retirement Plans
Children as Tax Shelters
Business Entertainment and Meals
Education Expense
Longevity or Productivity Awards
Dues and Subscriptions
Conventions and Continuing Education
Independent Contractor Agreement

Other Financial Considerations
Electing a Fiscal Year
Interest-Free or Low-Interest Loans

Other Operating Considerations
Accounts Receivable and Accounts Payable
Signature Block
Licenses
Qualification in Other States or Countries
Preservation of Name or Trademark
Address and Bank or Merchant Accounts
Annual Meeting

Recommended Links

http://www.incnow.com/tax.shtml