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A Family Limited Partnership (FLP) has been a popular business entity for Wealth Management, tax minimization and wealth transfer maximization. Under the right circumstances, FLP s traditionally helped taxpayers remain in control of their wealth even after transferring it to their loved ones. Additionally, many of these transfers were made at a significant discount; thereby further leveraging wealth transfer tax savings. Not surprisingly, while FLP s have been employed as a planning panacea by taxpayers, FLP s have been employed as a planning panacea by taxpayers; FLP s have received the evil eye from the IRS and some courts with increasing frequency.

Background

Simply put, an FLP is a Limited Partnership among family members. The FLP is often created by the wealth-owning generation, typically the parents. The FLP creators are initially both the General Partners (GPs) and the Limited Partners (LPs) at the time they contribute assets the FLP. The lion's share of the contributed assets is thereafter assigned to the LP shares. Even so, the GPs hold all of the management control over the FLP assets.

When the FLP assets generate income, the GPs are entitled to compensation for their management services. LPs enjoy an ownership interest only. They have limited authority and there are restrictions on the transferability of their LP interests. This lack of control (minority interest) and inability to transfer the LP interest freely (lack of marketability) reduces or discounts the value of the FLP assets. In turn, this discounting enables the parents to transfer more wealth (and the future appreciation of that wealth) via their LP interest to younger family members, yet retain lifetime control over that wealth.

Other benefits include income splitting and asset protection, since FLP income may be spread among multiple family members and creditors of the LPs may be limited in their attempts to reach underlying FLP assets.

IRS & Judicial Attacks

Given the powerful tax and wealth transfer benefits available through FLP s, it is easy to see why the IRS and some courts do not like them. First and foremost, an FLP must be created for a business purpose…not just for estate planning. For example, a valid business purpose may be to maintain family ownership and control of assets while they are transferred between generations free from the claims of third-party creditors and probate. Any planning with an FLP must begin with a solid business purpose in substance as well as in form.

Like most legal arrangements that offer both tax minimization and wealth transfer maximization, FLP s are subject to an unwritten rule of law: pigs live and hogs get slaughtered. Some examples of hoggish behavior with FLP s include taxpayers who establish deathbed FLP s and/or taxpayers who transfer substantially all of their personal assets and means of financial support to their FLP s (i.e. leaving themselves no other source for income and sustenance.) Result: If an FLP is found to be hoggish, then the entire value of the underlying FLP assets may be included in the estate of the FLP creator by the IRS and some courts.

As you might imagine, in addition to the FLP s business purpose, the IRS has traditionally scrutinized the valuation discounts claimed by the taxpayer for the LP interest. Once these gifts are made, the taxpayer must ensure that any discounts attributed to the gifts are substantiated in writing by an appropriate valuation expert and that these discounts are reported on a timely gift tax return. Expert professional valuation assistance is critical to successful FLP planning, implementation and maintenance. It is money well spent.

Practical Considerations

FLP's are not for everyone. Between legal fees, valuation fees, required state filings and reports, and tax returns (for the FLP, the GPs and the LPs), FLP s may require a substantial commitment in time and resources. Also, given the increasing IRS/ judicial scrutiny, even the once favorable tax treatment of FLP s is in a state of flux.

Summary

This has been brief, general overview of an extremely complex topic. Accordingly, you must carefully weigh the costs versus the benefits of FLP planning before proceeding, especially in light of the practical considerations. Note: If you have created an FLP and/or are a GP or LP of one, then you should consult with qualified legal counsel for a thorough review of the arrangement.




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