Family Limited Partnerships, hereinafter “FLP’ are a special type of limited partnership, that can be used in conjunction with an estate plan, an asset protection plan, as well as a financial plan.
What is this wondrous vehicle and how does it work? The purpose of this article will be to address these concerns.
Family Limited Partnership
A FLP, is a limited partnership, composed of family members. A limited partnership is filed pursuant to the Revised Uniform Limited Partnership Act. By executing and filing a certificate of limited partnership, a limited partnership, under Illinois law, comes into being.
A certificate of limited partnership has nine enumerated requisites pursuant to 805 ILC2 210/201 including:
- The limited partnership’s name;
- The purpose for which the partnership is formed;
- The address of the office at which the records required by statute are kept and the registered office’s address;
- Name and address of each general partner; and
- The value of property contributed to or agreed to be contributed
The essence of a limited partnership is the creation of two classes of partners, the general partner, the one that control the entity, and the limited partners, the ones who have no voice in any management decisions. Therefore, the general partner runs the show, and the limited partner sits by the sidelines. These are a variant of the misguided entities used with tax shelter transactions.
Parents or older family members, the ones with more assets, initially are general partners, as well as the majority limited partners. Children or younger generation family members would have very small interest initially as limited partners. They could annually be gifted additional limited partnership interests subject to the annual gift tax exclusion, currently $10,000.00 per person. Since all partners would be related, the term, FLP, is used to refer to this entity.
What Does It Do?
A limited partnership has three major advantages relating to estate planning and asset protection:
- Separation of Ownership
A FLP allows a division between who owns the property, and who controls it. For example, if the general partner, parents, only own 1% interest in a FLP, and the children own a 99% interest as limited partners, the parents, general partners, control all assets. It is important to remember limited partnership law, the general partner runs the show. Limited partners, not only have limits on liability, but have no right to participate in FLP business affairs.
- Valuation Discounts
New revenue rulings, concede that owning less than the whole asset, means that parts of the asset are not worth as much. For example, if you tried to sell someone 20% of your house, there would probably be very few outside takers. Another example would be selling 20% of a car. Again, not too many takers.
The IRS has recently adopted the same position relative to family members. Even if a family in the aggregate owns 100% of an asset, a discount is available to each owner, if each individual member does not own 100% of the asset. In Revenue Ruling 93-12, 1993-7 IRB 13, a parent transferred 100% of the shares in a closely held corporation, 20% each, to his five children. In the aggregate, his children therefore owned 100% of the corporation. Prior to the ruling in question, the IRS would use attribution rules and allege that each of the five children constructively owned 100% of the stock. This would, therefore, not allow for a minority discount to be applied to any child’s interest.
In Revenue Ruling 93-12, the IRS changed its position and now allows each minority interest of a child to be valued as a minority interest, and not aggregated. Therefore, an appropriate discount to valuation, somewhere between 15 to 22% may be present relative to each interest in the partnership. Additional restrictions on transfer of an interest could increase the discount to 30 or 40%. Thus, a one million dollar valued property, might only be worth seven hundred thousand if each 20% interest was entitled to a 30 % discount, by usage of a FLP. This can result in big estate tax savings, considering estate tax ranges from a minimum of 37% up to a maximum of 55%.
- Asset Protection
An additional aspect of a FLP is asset protection. In a properly structured limited partnership, a creditor, who obtains a judgment against any partner, may not attach partnership property. Instead, a creditor may obtain a “charging order” against the partnership interest. The charging order does not allow the creditor to attach partnership property, nor does it allow the creditor to become a partner, or to liquidate the interest, if the FLP is properly drafted. Instead the creditor obtains the profit or loss from the partnership interest it attaches to.
- What’s so great about this?
The answer is found in Revenue Ruling 77-137. In Revenue Ruling 77-137, the individual at issue obtained an assignment of a limited partnership interest. The IRS ruled that the assigned partner must report the distributive share of partnership items of income, gain, loss, deduction and credit attributable to the assigned interest just as if the person was a substituted limited partner. This was notwithstanding the fact that no money was distributed from the partnership, yet taxable income had to be included on the judgment creditor’s income tax return. Therefore, you could cause a judgment creditor to pay income tax on money they would not receive. This makes a charging order highly ineffective and quite costly.
Therefore, the three elements as discussed above, valuation discounts, separation of ownership, combined with asset protection, makes a FLP an ideal vehicle to hold liquid assets, as well as other assets in your estate plan.
Remember, a FLP, is only one tool to be used in conjunction with your overall estate plan, asset protection plan and financial plan.
Richard M. Colombik, JD, CPA, is the principal in the law firm of Richard M. Colombik & Associates, P.C., and serves as chairman of the Federal Taxation Council. He is an elected representative in the Illinois State Bar Association Assembly, and also serves as liaison to the IRS district director for the Illinois State Bar Association. He can be reached at 630-250-5700.