Family Limited Partnerships
The use of family limited partnerships in estate planning
The transfer of assets from generation to generation is often a complicated affair. A taxpayer can reduce his or her estate tax liability through gifts of cash and assets. However, immediate and absolute gifting is a two-edged sword: one edge ensures a larger estate to heirs and the other brings the loss of control over transferred assets. The question becomes: How may the taxpayer both reduce his estate tax liability and maintain control over his or her assets?
The answer is a Family Limited Partnership. The Family Limited Partnership works to allow the senior (or parental) generation to maximize gifts during their life, while maintaining control of cash assets. The Family Limited Partnership structure allows the taxpayer to shift assets, plus their appreciation and income, to potentially lower tax-bracket children and grandchildren. Yet, while these junior generations obtain interests in the assets, their liability for partnership debt is strictly limited to their interests in the assets of the partnership.
In addition, partnership assets themselves receive protection from creditors of the partners. Because of flexibility, the Family Limited Partnership is an ideal substitute for the irrevocable trust. For these and other reasons, the Family Limited Partnership remains the entity of choice for many knowledgeable business and estate planners.
Typically, the senior generation (parents or grandparents) makes a nontaxable transfer of assets to the partnership in exchange for partnership units. The partners may then begin the systematic gifting of limited partnership units to junior generation members, bringing the junior generation into the partnership.
The Partnership Agreement limits the transferability of the limited partnership units and the owners of these units do not exercise management control over the Partnership. Thus, the value of each unit is reduced or “discounted” to a value less than the actual share value of the Partnership assets.
Control rests with the general partner, usually the senior generation, who manages the partnership activity and assumes personal liability for the debts and obligations of the partnership. The limited partners play no role in the management of the partnership, and their liability is limited to their interest therein. The goal of the senior generation is to gift away the largest portion of the Partnership, in limited partnership units to the junior generation, while retaining a controlling interest as a general partner. This allows the senior generation to remove the maximum amount of the value from their taxable estate, while preserving control over partnership activity.
The Family Limited Partnership offers numerous tax and non-tax advantages. One benefit is that the Family Limited Partnership may serve as an important estate planning tool whereby property (both that given away during lifetime and that held at death) may qualify for “valuation discounts.” Valuation discounts allow the asset holder to leverage the annual gift tax exclusion and unified credit, allowing the senior generation to transfer more assets to the junior generation with significantly reduced gift and estate tax liabilities. Another benefit is that the Family Limited Partnership may allow senior generation family members to shift a portion of income earned by their closely-held business to other family members, while retaining control over that business.
As general partners, the senior generation maintains control over distributions of income to partners, and accordingly, determines the timing and amount of income distributions made to the junior generation. Finally, when an individual contributes assets to a limited partnership in exchange for an interest in that partnership, the contributor no longer owns those assets.
Therefore, the transfer of assets limits a creditor’s ability of attachment to the assets themselves. A creditor may obtain a “charging order,” which assigns to the creditor the partnership profits allotted to that limited partner. The creditor’s interest is limited to the right to receive profits when and if distributions are made.
A Family Limited Partnership may be the answer for you. We strongly recommend that you get in touch with our office at (520) 797-1400 to schedule a consultation in order to learn more about a Family Limited Partnership