Family Limited Partnerships: A Panacea for All Estate Planning Ills?
Family Limited Partnerships: A Panacea for All Estate Planning Ills
Family limited partnerships are being touted by many as a miracle drug in the context of estate planning ills. In fact, the family limited partnership is a very sophisticated and effective tool, but appropriate for use only after careful consideration of a family’s circumstances and all state and federal laws.
BACKGROUND: Family limited partnerships burst on the scene following a dramatic reversal by the IRS of its adverse position relating to the availability of minority discounts and discounts for a lack of marketability in the family context. This reversal came as a holiday gift to professional estate planners, the ruling having been announced on December 24, 1993. With the IRS apparently conceding that minority and marketability discounts could be appropriate in the family context, estate planning professionals began jumping on the opportunity.
THE ENTITY ITSELF: A family limited partnership is not a unique legal entity, but rather is a regular limited partnership (which has been around for decades) made up of family members or family trusts. Every limited partnership is required to have at least one general partner and at least one limited partner. The general partner has complete control over the management of the partnership’s affairs, including its assets. The limited partner is merely an investor and has no right to participate in the day-to-day business of the partnership. Accordingly, a family limited partnership with a 1% general partner and a 99% limited partner effectively gives the general partner complete control of the partnership and its assets, even though the general partner owns only 1% of the partnership. Many parents respond favorably to this concept! Incidentally, an individual or trust can be both a general and a limited partner.
ADVANTAGES OF FAMILY LIMITED PARTNERSHIPS: The principal business reasons associated with the use of family limited partnerships include:
- centralized control over the management and investment of family assets;
- cost savings by consolidating family assets into one entity; consolidation of investments of real estate into a partnership, allowing the property to be developed or managed in an orderly manner;
- avoidance of problems typically created when undivided interests in real estate become
owned by multiple individuals;
- asset protection from potential domestic relations problems;
- an effective way to implement a gift-giving program;
- protection for limited partners against claims of future creditors;
- avoidance of out-of-state probate since partnership interests are personal property;
- control over family assets through a buy-sell arrangement included in the partnership agreement.
TAX ADVANTAGES: Use of a family limited partnership can produce very substantial tax advantages, particularly in the estate and gift tax arena. These advantages stem from the valuation discounts which are available for lack of marketability, lack of transferability and minority ownership status. These discounts can range from 15% to 60%, but generally fall in the 30% to 40% range. Example: Parents own real estate investments and marketable securities worth $1 million and contribute the assets to a family limited partnership in exchange for a 1% general partnership interest and 99% of limited partnership interests. A 35% discount applied to a 1% limited partnership interest results in a value of $6,500 per interest, rather than a value of $10,000. Accordingly, the parents together could give each child (and each grandchild, if done carefully) a 3% limited partnership interest utilizing the $10,000 annual exclusion for gift-tax purposes. Note that the 3% partnership interest reflects $30,000 of underlying asset value.
This same leveraging effect would also apply to the use of the $600,000 exemption equivalent, effectively allowing the parents to transfer substantially more assets to their children on a tax-free basis than can be accomplished without using the family limited partnership.
At an estate level, the family limited partnership interests held by an estate should be discounted for estate tax purposes and will be if properly implemented.
DISADVANTAGES OF FAMILY LIMITED PARTNERSHIPS: The biggest disadvantage of establishing a family limited partnership is the cost of establishing and maintaining the entity. The legal fees relating to this tax planning are substantial. There are also appraisal costs in order to establish values for transfer tax purposes and costs for preparing the additional income tax return required to be filed by the partnership itself (although the information required for the partnership is readily available and would be included on the individual’s income tax return in any event). In the final analysis, the cost of utilizing this sophisticated device will be compared to the potential tax savings attainable from its use, which can be very substantial.
CONCLUSION: Although not necessarily a panacea for all tax-related problems, the family limited partnership provides tremendous potential for tax benefits to a family when properly implemented.
Copyright, Gentry Locke Rakes & Moore, November 1996