Accounting and Tax Services, Medical Practice Management, Personal Financial Planning Oversight
Jun 06

Potential Benefits Available through Family Limited Partnerships

There are many reasons for the continuing popularity of FLPs. Benefits of using an FLP to transfer assets include the following; be sure you talk to your estate planning attorney about FLP advantages for you and your family:

  • Income Shifting. Although much of the unearned income of children under age 24 is taxed at the parent’s rate, FLPs continue to be widely used as income-shifting devices, especially to older children.
  • Estate Freezes—Diversion of Appreciation. Through gifts of interests in FLPs that own appreciating assets, a senior-generation family member can remove future appreciation in value from his or her estate. This avoids the taxation that would result if the property were transferred after the appreciation occurred. This is the classic goal of an estate freeze.
  • Gaining Transfer Tax Leverage. Most partnership interests, especially noncontrolling interests, have a value that is less than the interest’s proportionate share of the value of the underlying business or assets. To the extent this discount in value is reflected in the transfer tax value of the gift, value can be removed from a senior generation family member’s estate on a tax-advantaged basis.
  • Maintaining Control over Assets. A senior-generation family member can use an FLP to make gifts while maintaining a high level of control over the underlying assets, such as a business operated through the partnership, property being developed through the partnership, or assets being managed through the partnership, as the case may be. However, the level and manner of maintaining such control has become an issue in transfer tax cases.
  • Facilitating Gift Programs. An FLP can be used to make repeated transfers of limited partner interests as part of a regular program of gifts to family members. This is a convenient way to take advantage of the annual gift tax exclusion.
  • Flexibility in Management. Compared to a trustee, a general partner of an FLP has more flexibility in managing assets. While often subject to fiduciary obligations, a general partner managing partnership assets generally will be judged against the business judgment rule standard (prudent business person) instead of the standard applicable to trustees.
  • Avoiding Local Probate. The estate of an owner of real property would be required to probate the property in the state where the real estate is located, even if this differs from the state of the decedent’s domicile. If the property is owned through a partnership, the decedent would not own a direct interest in real property, but would own an interest in a partnership, which is intangible personal property. This would be probated with other personal property in the jurisdiction of his or her domicile, simplifying the process and minimizing costs.
  • Avoiding Fractionalization of Title. Especially where real estate is involved, there is a benefit to avoiding multiple undivided interests. Obtaining proper consents to leases and other agreements becomes cumbersome with multiple owners, and the likelihood of title problems increases greatly as the number of owners increases. Moreover, undivided interest owners often possess a right to partition the property. An FLP may be used to create a single owner, simplify property management, and avoid partition risks.
  • Providing Protection against Creditors. In most situations, a creditor of a partner cannot reach the assets of the partnership or compel distributions, but can only obtain a charging order, by which the creditor may receive distributions that are made with respect to the interest, and, in some circumstances, a foreclosure and sale of the interest, nevertheless keeping the partnership intact. As a consequence, the opportunities for a creditor of a partner to benefit from the debtor’s partnership interest are far less than where there is direct access to the underlying property. However, be aware some courts are viewing the situation with greater scrutiny and more sympathy to creditors.
  • Controlling Donee Access to Wealth and Income. While senior generation family members often desire to transfer property to their children and grandchildren, they sometimes are concerned about how these donees will behave if they have immediate access to the wealth. By transferring FLP interests, the wealth can be transferred, but liquidity can be controlled to some extent. The younger generation member cannot easily convert the FLP interest to cash. Moreover, subject to some limitations, a general partner can exert control over the extent and timing of distributions and the reinvestment of income.
  • Taking Advantage of Investment and Diversification Opportunities. Some investment managers will not work with portfolios that do not meet certain threshold values, and where they do work with smaller portfolios, the management fees are often higher. An FLP is a convenient way to consolidate assets into larger blocks that might qualify for some of the benefits available to larger portfolios. In other situations, the consolidation of assets through a partnership may provide greater opportunities for diversification than if each partner held smaller portions of the same assets.
  • Preserve and/or Coordinate an Investment Philosophy. An FLP may provide a mechanism by which the donor and the other partners may preserve or foster a particular approach to investing, especially as it may relate to the assets contributed to the partnership.
  • Maintaining Family Control. An FLP with appropriate buy-sell provisions can be used to keep control of assets or a business within a family. This can provide protection against disruption and acrimony that sometimes accompanies failed marriages and the resulting property divisions.
  • Flexibility to Adapt. There is far greater ability to amend a partnership arrangement to adapt to changes in circumstances than there is in the case of an irrevocable trust.
  • Managing Disputes. A partnership agreement can be used to require arbitration of family and business disputes, as well as to establish other ground rules, such as the sharing of expenses of a dispute.
  • Avoiding Guardianship. The partnership agreement can be drafted to avoid the cost and burden of establishing guardianship in the event of incapacity of one of the partners.
About Reed Tinsley, CPA

As a top advisor to physicians, I help increase practice profits by delivering hands-on, expert medical accounting/tax support, practice counsel, and revenue-building strategies. Read more →