How to Lower Estate Taxes Using a Family Limited Partnership
By: Anthony Santoro, Esq.
Family Limited Partnership: What It Is & The Tax Advantages
Family limited partnerships (FLPs) are an effective but often under-utilized estate planning tool that families can use to reduce or eliminate estate taxes paid by their beneficiaries. Read on to see if establishing an FLP might be a smart strategy for you.
What is a Family Limited Partnership?
As the name implies, a family limited partnership is a partnership controlled by family members. There are two types of partners: general and limited.
- General partners (GPs) control management and investment decisions and assume full liability.
- Limited partners (LPs) receive creditor protection and face limited liability, but they can’t participate in management of the partnership by controlling or directing operations in any way.
The general partner — usually a senior family member — will transfer business interests, marketable securities, real estate, and other assets to the FLP while retaining control over them. GPs can continue to gift additional partnership interest annually to their children and grandchildren using their annual gift tax exclusion ($17,000 in 2023). This way, GPs can retain management control of the business while lowering the value of their taxable estate, and thus the amount of gift and estate taxes due upon death.
Another benefit of FLPs is that limited partnership interests have diminished marketability since the holders have little or no control over the partnership. As a result, these interests may qualify for valuation discounts for lack of control or marketability. Also, since FLPs are pass-through entities, business income and future appreciation of assets can be shifted to family members who are in a lower tax bracket.
GPs can make stipulations in the partnership agreement to protect assets from being mismanaged by their heirs. For example, they can require that gifted shares not be transferred to LPs until they reach the age of majority or even older.
FLP vs. LLC
There are several differences between an FLP and an LLC that you should be aware of. An LLC can enable all members of the LLC to participate in managerial decision making whereas only the general partners have managerial decision-making authority in an FLP. Additionally, an FLP protects only the limited partners from liability, whereas an LLC protects all members from liability. Lastly, FLPs can offer unique tax benefits when assets are transferred from senior members to junior members as an inheritance. We will cover this in more detail later.
FLP vs. Trust
While a trust is established to hold property for the trust’s beneficiaries, an FLP is technically a business in which members profit according to their general, or limited partnership shares.
Should You Set Up an FLP?
Increased for 2023, up to $12.92 million of an individual’s estate (or $25.84 million for married couples) can be passed on to beneficiaries free of federal estate tax. The value of your estate that exceeds this amount is subject to federal estate tax at rates as high as 40%. Additionally, unless Congress acts, the estate exemption is slated to be cut in half by 2026. If your estate is larger than this, or if you believe it could be larger than this when you die, then setting up an FLP might be a smart strategy for you and your family.
For example, let’s say that you and your spouse’s estate is worth $30 million. This includes a growing family business currently valued at $15 million and another $15 million worth of securities, real estate, and other assets. If you both die in 2022, your beneficiaries could face an estate tax burden of $2.4 million (40% x $6,000,000) in addition to possible state estate taxes, depending on where you and your heirs live.
By transferring your business and assets into an FLP and gifting LP interests to your children and grandchildren, you could reduce the value of your business to $10.5 million via the 30% lack of marketability discount. This would reduce the value of your estate to $25.5 million and the estate tax bill to $600,000, saving heirs almost $2 million in federal estate taxes (in this example). What’s more, as the business and its valuation continue to grow over the years, this growth will occur outside of your estate.
Run Your FLP Like a Real Business
Keep in mind that family limited partnerships are real business arrangements and must be run like a real business. For example, regular meetings must be held, and minutes taken, and reasonable compensation must be paid to the GP in accordance with the Internal Revenue Code. Also, since the FLP is a pass-through entity, LPs are responsible for paying taxes on their share of income generated by the business. This may necessitate making annual distributions to the LPs.
Downsides to FLPs
The biggest potential drawback of FLPs is usually the cost and complexity involved in setting them up. Establishing an FLP may require the services of a tax specialist, estate planning attorney and possibly other experts.
Also, the IRS has taken an interest in FLPs recently, claiming in court that some FLPs were set up for the exclusive purpose of avoiding federal estate taxes. So, it’s important to be able to demonstrate and document legitimate non-tax reasons for setting up an FLP that go beyond just tax savings. For example, you could use an FLP to keep ownership of a business in the family, allow for the gradual transfer of ownership over time while retaining control, or to protect assets from the claims of future creditors.
How A Financial Advisor Can Help
A Simon Quick advisor can help you determine if establishing a family limited partnership is a smart strategy for you and your family. To learn more, call us at (973) 525-1000 or send an email to email@example.com.
About Anthony Santoro
Mr. Santoro joined Simon Quick in 2022 and currently serves as a Client Advisor. His expertise includes tax, executive compensation, estate planning, and wealth transfer. At Simon Quick, Anthony provides clients with holistic oversight and counseling at the intersection of law and finance. Prior to Simon Quick, Anthony worked as an attorney, where he concentrated his practice on trust and estate planning and administration, representing owners of closely held businesses and principals of private equity funds. Anthony began his financial services career with Ayco, a Goldman Sachs financial planning-focused firm. Most recently he served as an Attorney in a Trust and Estates Law Firm and as a Partner and Family Office Director with their affiliated RIA. Anthony graduated with a BS from SUNY Albany and his Juris Doctorate from Albany Law School. He is a member of the New York State Bar Association and Financial Planning Association of Northeastern New York. To learn more about Anthony, connect with him on LinkedIn.
Simon Quick Advisors, LLC (Simon Quick) is an SEC registered investment adviser with a principal place of business in Morristown, NJ. Simon Quick may only transact business in states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. A copy of our written disclosure brochure discussing our advisory services and fees is available upon request. References to Simon Quick as being "registered" does not imply a certain level of education or expertise. No information provided shall constitute, or be construed as, an offer to sell or a solicitation of an offer to acquire any security, investment product or service, nor shall any such security, product or service be offered or sold in any jurisdiction where such an offer or solicitation is prohibited by law or registration. Additionally, no information provided in this report is intended to constitute legal, tax, accounting, securities, or investment advice nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. It should not be assumed that future performance of any specific investment or investment strategy will be profitable, equal any corresponding indicated performance level(s), be suitable for your portfolio or individual situation, or prove successful.