Business succession planning is one of the biggest concerns for business owners. While there are several options to consider, transferring ownership and control of the company to the next generation is one of the most common. A Family Limited Partnership can be a beneficial strategy for wealth preservation, as it allows owners to enjoy the tax benefits of gradually transferring ownership while still retaining control of the business. While this transfer can bring significant tax benefits, owners need to start planning for this long before they’re ready to hand over the reins.

How it works

A Family Limited Partnership (FLP) is an arrangement where each family member buys or receives gifts of units or shares of the business and can profit in proportion to the number of shares they each own. To establish an FLP, your ownership interests are transferred to a partnership in exchange for both general and limited partnership interests. The limited partnership interests are then transferred to your children or other beneficiaries.

As a general partner, you can still make business decisions and run the day-to-day operations while retaining the general partnership interest, which may be as little as 1% of the assets.

Benefits

When the FLP interests are transferred to your children, so is the value, along with future business income and asset appreciation associated with those interests. Because your children hold limited partnership interests, they have no control over the business nor would they be able to sell their interests without your consent or force the FLP’s liquidation.

With limited control and lack of an outside market for the FLP, interests generally mean the interests can be valued at a discount — so greater portions of the business can be transferred before triggering gift tax. For example, if the discount is 25%, in 2019 you could gift an FLP interest equal to as much as $20,000 tax-free because the discounted value wouldn’t exceed the $15,000 annual gift tax exclusion. Please note, however, you would still need to file a gift tax return to disclose the valuation of the interests that are being transferred.

There also may be income tax benefits. The FLP’s income will flow through to the partners for income tax purposes. Your children may be in a lower tax bracket, potentially reducing the amount of income tax paid overall by the family.

Additionally, establishing an FLP may give you a great opportunity to introduce younger family members to the business and can be used as a tool to educate them on how the business runs.

Planning

The IRS pays close attention to how FLPs are administered. Lack of attention to partnership formalities, for example, can indicate that an FLP was set up solely as a tax-avoidance strategy. If the IRS determines that discounts were excessive or that your FLP had no valid business purpose beyond minimizing taxes, it could assess additional taxes, interest and penalties. We strongly recommend good governance policies be in place and be practiced. Involving the younger members of the family helps them understand what good governance is and how to protect the business.

Not for everyone

An FLP can be an effective succession and estate planning tool but it’s far from being risk-free. It’s important to discuss these steps with your advisors before setting up the FLP. Please contact us for help determining whether an FLP is right for you or to discuss other wealth and succession planning strategies.

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