A Family Limited Partnership (FLP) is a form of a limited partnership among members of a family. The main advantages of forming and funding an FLP involve estate and gift tax savings and asset protection. An FLP also allows you to retain control over the transferred assets while enjoying these advantages.
Once the FLP is established and your assets are transferred to it, you can make gifts of limited partnership interests to your children or other beneficiaries. This accomplishes several different estate planning objectives simultaneously.
The value of each limited partnership interest which you give away decreases the value of your taxable estate and, consequently, any tax which your heirs would have to pay upon your death. The gifts are made using the annual gift tax exclusion, so you do not have to pay any gift tax on the transfers up to the exclusion amount ($5.36 million in 2014).
A family limited partnership or a limited liability company can provide important tax and nontax benefits. From a non-tax standpoint, these entities are important in that they can provide a vehicle for managing family assets, and can protect you from liabilities arising in connection with the assets held in the FLP or LLC. It can also provide asset protection, in that a creditor who seizes the partnership interest from you will succeed only to your rights, and may not be able to force a liquidation of the partnership (making it a much less attractive asset to seize.) Thus, a FLP or LLC is an excellent way to own buildings or an unincorporated business.
From an income tax standpoint, a FLP or LLC can be superior to a corporation because there are no federal income taxes, and minimal or no state income taxes, on the income. From a gift and estate tax planning standpoint, a FLP or LLC can give rise to significant valuation discounts.
If a person owns a percentage interest in a FLP or LLC, the value of that interest will be less than the same percentage of the value of the net assets of the partnership. For example, assume that a FLP owns assets worth $100,000, and you own 10% of the partnership. Generally, your interest would be worth less than the $10,000 you’d receive if the partnership terminated and distributed the assets to the partners. That’s because you probably can’t force the partnership to terminate and distribute the assets. Rather, you’re entitled only to whatever distributions the general partner of the FLP or manager of the LLC elects to make. Typically, discounts will range from 15% to 40%, depending on the facts of the case.
If you make gifts of interests in a FLP or LLC, the value of the gift is based on the rights that the recipient has in the interest. Thus, the more power you retain in the partnership (and the less power the recipient has over the partnership), the smaller the value will be for the gift. On the other hand, on your death, the value of the asset in your estate will be based on the rights you’ve retained. Thus, the more power you retain in the partnership (and the less power the recipients of gifts you’ve made have received), the greater the value will be in your estate.
For California real property, there are important differences between the property tax treatment of real estate transferred by a parent to a child, as opposed to an interest in a FLP or LLC owning real estate which is transferred to a child. In some cases, where the property tax assessed value for a property is much lower than the current value of the property, it may make sense not to use a FLP or LLC to own that property.