In a previous post, I discussed the advantages of utilizing a family limited partnership—or FLP—to help protect your family business and pass it down to the next generation. The benefits of FLPs are not, however, limited to the family business. The ability of family limited partnerships to lower estate tax liability makes them a valuable estate-planning tool for larger estates, even in the absence of a family-owned business.
An FLP can hold most asset types. While there are some exceptions—such as the stock of an S corporation—an FLP may be utilized for much more than holding a family business. An FLP can hold the bulk of your wealth, should you so desire, and can therefore be used to pass down property to the next generation as seamlessly—and tax-free—as possible.
Say, for example, that over the course of your life you and your spouse accumulate assets totaling $20 million in value. These assets will be subject to the federal estate tax at death, so you want to remove as much as possible from your estate to help ensure that your heirs—not Washington—inherit the fruits of your labor. (These fruits, it may be added, have already been taxed once—and if any of your wealth stemmed from corporate profits, twice—already.)
You cannot, however, simply give your money away while you’re still alive, as this would evoke the gift tax, a backstop tax designed to frustrate efforts to avoid the estate tax. It should be noted, however, that gift taxes do not apply to charitable gifts, so charitable giving can and should be a part of most estate plans.
Gifting to your heirs, or anyone else for that matter, does evoke the gift tax, and so proper planning is necessary to ensure that as much of your wealth as possible is passed down to your children or other chosen heirs.
Family Limited Partnership to Lower Estate Tax Liabilities
The family limited partnership is a good way to do this. By forming an FLP and transferring your assets to it, you may maintain control of the assets by naming yourself—or an entity you control—the general partner, while gifting away portions of your estate to your heirs through FLP limited partnership units.
Any gifts valued at less than $14,000 per person per year—this is the 2013 amount but it is adjusted annually for inflation—are not subject to the gift tax, and so you can gift away $14,000 to each recipient annually without incurring gift tax liabilities. This means that both you and your spouse can together gift away $28,000 per year to each heir—or anyone else for that matter.
So, for example, if your children are your sole heirs and you have five children, you can gift away FLP interests worth $140,000 per year without any gift tax consequences. That translates into $140,000 that not only escape gift tax liabilities but also eventual estate tax liability.
The process is sweetened, however, by valuation discounts. Since a limited partnership interest in an FLP does not provide control of the entity and is not easily marketable, the value of the gift is discounted.
This means that a 20% limited partnership interest in an FLP is not worth 20% of the entire value of the FLP, but often much less. A 30% discount is not uncommon with much greater discounts not beyond the realm of possibility. This means that that $14,000 annual gift can go much further than immediately apparent.
In addition, once the amount is gifted over, it can continue to grow in value while remaining excluded from your taxable estate. This is where the ability of the family limited partnership to lower estate tax liabilities becomes readily apparent.
Over several years, you can transfer large amounts of your wealth to your heirs and mitigate—or eliminate—your estate and gift tax liabilities all while maintaining control of your assets.
There are, however, some restrictions on what you may do with FLP property. Utilizing an FLP for estate-planning purposes can, therefore, be a somewhat complex matter requiring the guide of a competent attorney.