Families who own a business and wish to preserve their heirs' interests at a low tax cost should consider the family limited partnership (FLP), said Stephen M Feldhaus of Fulbright & Jaworski LLP.
"A lot of us leave a lot of money on the table when we die," he said. "The family limited partnership is a very effective tool for shifting wealth between generations while keeping the control under the direction of the senior generation and/or under the direction of whom the senior generation chooses."
Feldhaus discussed estate planning strategy for business owners at the annual National Tank Truck Carriers meeting May 18-20 in Washington, DC. He said many families involved in a business fail to conduct effective estate planning, and by doing so eliminate opportunities to pass on wealth.
The FLP is a highly effective tool for shifting wealth between generations at a reduced estate and gift tax cost. It keeps the wealth in the family and subject to the control of members of the older generation. Senior generations can make lifetime gifts of partnership interests to the younger generation.
There are no restrictions on either the number or the kinds of individuals or entities that can be partners, unlike an S Corporation where there are many restrictions on eligible shareholders. Partners in the FLP can be anyone who owns a capital interest in the partnership, regardless of whether such interest was acquired by purchase or gift from any other person.
Typically, a family limited partnership is formed by parents or grandparents transferring property to a limited partnership in exchange for general and/or limited partnership interests. Some or all of the limited partnership interests are then transferred by gift or sale to children or grandchildren, or into trusts for their benefit.
Principal assets of the family business are owned by the partnership instead of individual family members, but limited partners have the limited right to control, and even to participate in the partnership management. Assets to be transferred to this partnership can consist of investments or an operating business.
Estate and gift tax benefits from the partnership arrangement are available because limited partnership interests are a different kind of property from the underlying assets.
The partnership is an attractive way of organizing family-owned businesses for a number of reasons, he said. Initially, there is only one level of tax, rather than a dual level of tax that exists in a C corporation. Profits and losses are taxed to the partners and not to the partnership.
Limited liability is available both for the limited partners and, assuming the general partner is a corporation, for the general partner. The partnership helps conserve assets in the face of awards for personal injury, professional liability damage awards, and claims of creditors.
A creditor's only recourse is a charging order, a judicial assignment of a profits interest in the partnership, against a limited partner's interest. Unless the creditor can show that the partnership was motivated by intent to defraud or hinder the creditor, the creditor cannot acquire or vote the limited partner's interest, remove the general partner, force a liquidation, or force distributions. Since a creditor with a charging order will have to face a tax on the partnership's income, even if no cash is distributed, creditors are extremely reluctant to obtain charging orders.
With the FLP in place, certain business opportunities exist, such as if the owners identify trends in their industry and adapt accordingly to increase the future value of the company. Through the use of an FLP, they can transfer a substantial portion of future appreciation to the next generation free of estate and gift taxes.
Despite the advantages of the FLP, the Clinton administration is proposing curbs. Meanwhile, families should be looking at the FLP and considering it as a tool for estate planning, he said.