A recent study published by the Wall Street Journal makes claim that the United States has more millionaires currently than at any other time in history. With a growing global economy, and an estate tax system that does not look like it will go away any time soon, the U.S. Treasury may be eyeing up a huge windfall in the form of tax revenues. If you are a millionaire, use of the Family Limited Partnership may help you transfer some of your millions to your heirs instead of the government.
The Family Limited Partnership or FLP has long been used as a way to pass assets to heirs. An FLP is a limited partnership which is a vehicle used to essentially trade ownership in assets such as family owned businesses, real estate, and securities for lower estate and gift taxes. The key elements to making this vehicle work revolve around the concept of control and discount.
Generally, it is the desire of the person gifting an asset to somehow maintain control over that asset. In general, maintaining control of an asset impedes the estate planning process entirely. The FLP offers a way through this dilemma. Under the partnership structure, the owner of a business, real estate or securities will contribute the asset to the FLP. The owner (general partner) will keep a one percent or two percent interest in the FLP. The rest of the ownership interest (98 percent) can then be gifted to the limited partners (the heirs) either all at once or by taking advantage of the annual gift tax exclusion currently $11,000 per person. The general partner retains management control and may draw a management fee for compensation. The limited partners have no say in the day-to-day operations. However, distributions must be made proportionately to all partners.
The possibility of large tax savings can occur due to the concept of discounting. Because limited partners have no control over partnership assets, the value of those limited partnership interests is decreased. There are many types of discounts that can be used to reduce the value of the limited partnership interest. The marketability and minority discounts are typically used to value limited partnership interests. Recent court rulings have upheld discounts from as low as 40 percent to as high as 70 percent. The concept of discounting can translate into significant estate and gift tax savings.
There has been concern surrounding the FLP due to a recent tax ruling that levied a tax on heirs involved in an FLP. However, the FLP still remains a valid legal tool if it is properly organized and managed. The following are key points to note if you are considering forming an FLP:
1) The partnership must operate an active business.
2) Income should be passed to limited partners.
3) All partners must have a way to exit.
4) The partnership must have a valid business purpose.
Wealthy taxpayers and their advisors continue to use the FLP as a vehicle to transfer wealth at a discounted price to their heirs. The FLP also retains another major benefit to the wealthy known as asset protection. A creditor cannot pierce an FLP to get at the underlying asset, however the creditor can lay claim to partner distributions. Thus, through simple planning the FLP becomes an asset protection vehicle.
The FLP is most likely only for those that are wealthy. The cost to plan and prepare all of the necessary paperwork averages $25,000. Still, these partnerships increasingly are being used to hold family stock portfolios, real estate and businesses. Because of the prohibited costs involved in setting up one of these partnerships, it makes sense to have at least $2 million is assets that could be used as a capital contribution. Thus, the FLP appears to be only for millionaires.
Jeffrey J. Presogna is a CPA and CVA and has provided tax strategies, valuation, merger, and acquisition related services to a wide range of clients. He is Managing Director of the Northeast office of Vercor.
