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In this post, I discuss how a family limited partnership, or FLP, can be used to reap large estate and gift tax savings and why it’s become so popular.

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Family photo by Kevin Cramer 2012 is licensed under CC 2.0.

In a previous post, I discussed how family limited partnerships can serve as a vehicle for passing down a family business from one generation to the next. In this post, I will specifically discuss the benefits of family limited partnerships in relation to the estate and gift tax.

The federal estate tax—or death tax—is a tax imposed on the value of large estates. To avoid the tax, those for whom it is a concern seek to lower the value of their taxable estate as much as possible. Since generally only property that is in the estate at death is subject to the tax, gifting or spending assets prior to death can mitigate the amount due.

Gifting to Avoid the Estate Tax

Of course, Congress realized that gifting assets before death would be an easy way to avoid the estate tax, and so it imposed a gift tax as well. Subject to the same lifetime exclusion as the estate tax ($5,250,000 as of 2013), any gifts you give to any one person in excess of the annual exclusion ($14,000 as of 2013) are subject to a 40% tax. The estate and gift tax lifetime exclusions are unified, meaning that any gift tax lifetime exclusion you utilize during the course of your life will deplete the exclusion available for the estate tax at your death by the corresponding amount.

The $14,000 annual exclusion—which does not deplete the estate tax exclusion—therefore becomes very important. This $14,000 exclusion amount is available to each individual recipient, so while you may owe tax if you give one person $28,000, you would owe no tax if you give two people—or one million people—$14,000 each. (A married couple can combine their annual exclusion for a total of $28,000 per person per year.)

Here is where a family limited partnership—also known as an FLP—becomes particularly valuable. Every year, you could give each recipient—whether that be each child, grandchild, or whatever—an FLP interest worth $14,000. Over several years, therefore, you could gift away a large portion of your business, if not nearly all of it, without owing any gift tax, all the while maintaining complete control of the business.

FLP and Valuation Discount

There is another significant advantage of gifting FLP interests in this way. Let’s say that you own a business that you could sell today for $10,000,000. At first blush, it would appear that a 10% interest in that business would be worth $1,000,000, but this is not the case. A 10% interest would actually be worth significantly less. This is because the value of this fractional interest is based upon the fair market value of the interest itself and not simply a percentage of the value of the whole.

The marketability of the interest is reduced if the business is held in an FLP because an FLP interest comes with a lack of control, which significantly diminishes the value. In fact, discounts of 30% are usually considered conservative, while much greater discounts are not uncommon. Therefore, you can use this valuation discount to gift away partnership interests much more quickly.

Gifting Early

Of course, if you are married and have a business worth $10,000,000 today, you might not think you have to worry about the estate tax now. After all, the exclusion is $5,250,000 this year, and you and your spouse can combine your exclusions. Gifting early, however, makes it even easier to avoid the estate and gift tax.

If you started the gifting process today, you could gift away limited partnership interests much more quickly than you would be able to if your business were much larger. Then, if your business obtains even greater success, you’ll already find yourself in a situation where the gift and estate tax are not as great a concern.

Consider the example of Sam Walton. Sam Walton owned his business assets in a family limited partnership before founding the Walmart empire. As a result, at his death, the Walton family did not have to worry about the government showing up to take half of the wealth Mr. Sam had build because the Walton children already owned it.

Setting it up as an FLP was quite easy in the beginning. It would have been extremely difficult, however, to try to use a family limited partnership to mitigate the estate tax bill once Walmart had become a multi-billion dollar company. It would have taken centuries to do later what was easily done in the beginning.


See Also:

Protecting Your Business With a Family Limited Partnership

The Family Limited Partnership as an Innovative Estate-Planning Tool


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