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The Family Limited Partnership as an Estate Planning Tool

Family limited partnerships and limited liability companies ("FLPs") are attractive estate planning tools because they permit the donor to discount the value of gifts to the younger generation, retain control over the gifted assets, and protect the gifts from potential claims of the donee's creditors.

The FLP concept is fairly simple. The client contributes assets to a limited partnership in exchange for both general and limited partnership interests. The bulk of the initial capital contribution typically would be assigned to the limited partnership interests. For example, the partnership agreement might assign 1% of the initial capital contribution to the general partnership interests and the remaining 99% to the limited partnership interests. The client then gifts the limited partnership interests to his or her issue (or to trusts for their benefit) while retaining the general partnership interest.

The FLP is a very attractive tool because it permits the donor/parent to significantly discount the value of gifts to the donee/children that might not be discountable if made outright. Two discounts generally are available. They are a lack of marketability discount and a minority discount. A lack of marketability discount reflects the fact that the partnership agreement will restrict the sale or transfer of the partnership interests so that there is no ready market for those interests. A minority discount reflects the inability of the limited partner to compel partnership distributions or to compel liquidation to obtain his share of the assets which the partnership owns. It also reflects the inability of the limited partner to control partnership investments.

The combined discounts for lack of marketability and minority can be quite substantial and might range from 25% to 60%, depending upon the facts and circumstances. In order to be certain that the IRS will not challenge the discount taken years later, a detailed appraisal by a valuation expert must be obtained and filed with gift tax returns each year gifts are made. The IRS will then have only three years to challenge such discounting.

The discounts for lack of marketability and minority permit the donor to leverage his annual gift tax exclusion, unified credit, and generation skipping tax ("GST") exemption. For example, if the limited partnership interests are discounted by 40%, a married couple could give away to each child every year interests worth $33,333, rather than the usual $20,000, protected by the annual gift tax exclusion. Likewise, with a 40% valuation discount, a husband and wife could give away limited partnership interests worth $2,160,000 protected from gift tax by their combined unified credits, instead of just $1,200,000. Similarly, allocation of a married couple's combined $2,000,000 GST tax exemption to a trust for their grandchildren would entirely exempt from the GST tax a trust funded with $3,333,333 worth of limited partnership interests.

Depending on the circumstances, it might be possible to pair a FLP with the use of a grantor retained annuity trust ("GRAT") to achieve even further discounting.

The general partners in a family limited partnership have exclusive control over, and management of, the partnership assets. The limited partners, on the other hand, are entitled to a proportionate part of the income distributed by the partnership, if any, and to their proportionate share of the partnership assets upon termination of the partnership, but they have no right to control and manage the partnership assets.

Because the general partner has exclusive management and investment control over the partnership assets, a client may reduce his taxable estate by making gifts of the limited partnership interests while maintaining control over the underlying assets by virtue of retaining the general partnership interest.

The FLP agreement may restrict the limited partners' transfer of their interests and their ability to draw upon their capital accounts. However, care must be taken so as not to jeopardize the availability of the annual exclusion for gifts of the limited partnership interests. If the restrictions are too great, the gifts of the limited partnership interests might not be considered present interest gifts, which is necessary to qualify them for the annual exclusion.

Another advantage of the FLP is that it is difficult for creditors of the limited partners to reach the underlying partnership assets. This is significant for parents who want to transfer assets to their children, but are concerned a child might be sued or that a child's former spouse might obtain such assets in the event of a divorce.

FLPs are attractive tools to manage family assets, creditor protection, ease of gifting, and the leveraging of the unified credit amounts. §