Family Limited Partnerships (FLPs) have been a great estate and business management tool, as well as an excellent wealth transfer vehicle, for many years.
Although the Internal Revenue Service has placed increasing scrutiny on FLPs in the recent past due to some abuses, FLPs remain a valid, and very effective, estate planning tool for many people.
Let’s assume Mr. and Mrs. Smith own a farm in Dallas County. The Smiths would like to start gifting some of their assets to their three adult children. They may want to start gifting assets to get the kids involved in the farming operation, or for other estate planning reasons such as lowering, or eliminating, potential federal estate tax that could be due upon their deaths.
The use of a properly formed FLP will allow the parents to gift assets to their children at a higher value inside the FLP due to “minority interest” and “lack of marketability” discounting than they would be able to if the farm assets were outside of an FLP. In the year 2012, a person can gift up to $13,000 to any person without having any gift tax consequence, or the need to even file a gift tax return. If the Smiths wanted to give $13,000 in cash to each one of their children they could do so, which would effectively take $78,000 out of their estate ($39,000 from Mr. Smith to the three kids and $39,000 from Mrs. Smith to the three kids). However, by using an FLP the value they could gift annually could be much higher.
Here’s how it works. The Smiths contribute farm assets to the FLP which have a fair market value of $1,000,000. Mr. Smith and Mrs. Smith each receive a 1 percent general partner interest and 49 percent limited partner interest in the FLP for this contribution. Since Mr. and Mrs. Smith own all of the General Partner interests of the FLP, they will have control over the assets and direct how the FLP is to operate. They would also initially own the 98 percent in limited partnership interests. Limited partners do not have voting rights and thus do not have control over how the FLP is run and are, in a sense, “along for the ride.”
A short time after the FLP is formed, the parents then start gifting the limited partnership interests to their children. If the same assets are held outside an FLP, a 1 percent interest in those assets would be worth $10,000 ($1,000,000 x 1 percent). However, a 1 percent limited partnership interest is valued less because of the “minority discount” and the “lack of marketability” discounts mentioned above. Essentially, the value is less because the limited partner has little to no control over the FLP and no voting rights. A 30 percent combined discount would not be uncommon. Using a 30 percent discount factor, that $10,000 gift outside of the FLP turns into an approximate gift of $14,285 inside the FLP. This structure allows for greater tax-free gifting of wealth to a younger generation, which can be of significant importance in our current uncertain climate concerning the federal estate tax. FLPs can be complicated, so it is best to seek the guidance of an experienced attorney in this area.Information provided by Adam Doll, attorney at law, Hopkins and Huebner, P.C., 1009 Main St., P.O. Box 99, Adel, 515-993-4545, fax: 515-993-5214.