If you own a family business, at some point you may begin thinking about passing it down to the next generation. Succession planning can be an extremely complex and confusing process, particularly if you want to ensure the business stays in the family.
This can be even more difficult if you want certain family members to succeed you in leading the business, while allowing others to benefit from the business while remaining uninvolved. For example, your Wharton-educated son may be a good fit to run your business, while your daughter the engineer may have no desire to go into the family business. If you find yourself in this type of situation, a family limited partnership may be a good tool for you to use.
This type of structure can transfer both wealth and control of a business to the next generation in a way that is sensible and cost-effective. One big advantage is that partial—even majority—ownership can be transferred without your having to give up any control of the business.
How a Family Limited Partnership Works
There is really no such thing as a separate legal entity known as the family limited partnership. Rather, family limited partnership is a colloquial term used for limited partnerships that families utilize for estate and succession planning purposes. As such, a family limited partnership—or FLP—can have general partners and limited partners. General partners control the operation of the business, while limited partners have only an equity interest in the business. Limited partners cannot take an active role in the activities of the business but may only reap the financial rewards. Furthermore, the general partner controls the business even if that general partner possesses only a minority—even a small minority—interest in it.
Gifting Limited Partnership Interests
If you are the owner of a family business, you can gift limited partnership interests to other members of your family, such as children or grandchildren, through a FLP without giving up any control of the operation of the business. This can be done quickly or gradually, depending upon your individual goals and circumstances.
Using a family limited partnership for these purposes can also provide some significant tax advantages. In a future post, I will discuss how you can use a family limited partnership to pass down your family’s wealth to the next generation while avoiding a significant estate and gift tax bill.
Family limited partnerships are very flexible and can help you achieve a variety of goals. You can leave the business to all of your children, for example, but make only one a general partner to actually manage the business. If you so choose, you can provide general partners—including yourself—additional compensation by providing them with a salary in addition to their share of the profits.
How Would It Look
Let’s say, for example, that you own ABC, LLC as the sole member. You could create a family limited partnership called Smith Family, LP naming yourself as the general partner and your children as limited partners. You could then transfer all of your shares in ABC, LLC to Smith Family, LP, so that that the limited partnership, rather than you personally, owns the business. As I will discuss in a future post, you must be careful how much of a limited partnership interest you gift away in the beginning, as you could incur gift tax liability without proper planning.
Under such an arrangement, by acting as the general partner of the FLP, you would still have all the marks of ownership of ABC, LLC, particularly the ability to operate and manage the business. It allows you, however, to separate the financial interest in the company from the ability to manage it, thereby allowing you to plan for the succession of leadership without excluding your heirs from the financial benefits of the family business.
If you own a business in the corporate form, this must be done with great care. S corporation stock cannot be transferred to an FLP, and transfers of C corporation stock must be done carefully to avoid retaining the stock in the general partner’s taxable estate.