As I discussed in a previous post, the family limited partnership is a very powerful estate-planning tool that allows wealthy families to gift partnership interests in a family business to other family members while still maintaining control over the underlying business. If you have a closely held family business, a family limited partnership may be a valuable tool in your estate plan.
Wealthy families typically create family limited partnerships with three main objectives in mind: to lower estate and income taxes—indeed, family limited partnership taxation rules may be quite advantageous—to transfer ownership in the family business, and to establish liability protection for the limited partners.
The Family Limited Partnership Structure
A family limited partnership is not really a distinct business entity. Rather, it is a form of the limited partnership. Consequently, a family limited partnership has two types of partners: the general partners and the limited partners.
The general partner is typically a business entity, such as a limited liability company or corporation, owned by the owner of the family business. The owner of the family business can serve as the general partner personally, but since there is no limited liability protection for the general partner of a family limited partnership, having a business entity serve as the general partner provides liability protection for the business owner.
The limited partners have equity interests in the family limited partnerships but do not have the authority to act on behalf of the family limited partnership. The general partners control the day-to-day operations and make all the investment decisions.
The limited partners will, in most cases, simply receive an income from the partnership. These limited interests are generally gifted to family members, most often children.
Of course, there is no legal requirement that the limited partnership interests be given to family members. A limited partnership not kept within a family, however, would likely not qualify for the colloquial term “family limited partnership.”
Family Limited Partnership Taxation
One of the benefits of creating a family limited partnership is the ability to take advantage of the family limited partnership taxation rules. This can allow for the reduction of both income and estate tax liability.
When the family business is moved into the family limited partnership, there will be a taxable gift if someone other than the business owner or the owner’s spouse has an interest in the limited partnership. If they do not, a taxable gift will occur when the limited partnership interests are gifted to other family members.
The value of these gifts, however, can be discounted significantly because of the nature of the gift: a limited partnership interest that has little control. Since gift tax is paid on the value of the gift, a reduction in the value of the gift reduces the amount of gift tax due.
There may also be income tax benefits by dispersing the income to people in lower tax brackets than the original owners. Obviously, therefore, family limited partnership taxation rules can be quite advantageous. Individual circumstances vary, however, and so you should speak with a tax advisor to determine the income tax benefits a limited partnership could potentially provide.
The family limited partnership is a moderately complex and sophisticated estate-planning tool and so must be formed and planned very carefully. Before creating a family limited partnership, you should consult with competent legal counsel.