Family Limited Partnership

OTHER CONSIDERATIONS

Many estate planners and business consultants encourage their clients to look into FLPs, but they do note that family business owners should weigh some other non-tax factors as well. These include:

Lawsuit Protection A family limited partnership may serve as asset protection in the case of a lawsuit. Because the assets within an FLP are not the personal property of its partners, any legal judgement against one of the partners does not include the assets held by the FLP. The portion of the plaintiff's assets that are located within the FLP are thus protected from a legal judgment until disbursements are made from the FLP to the partner.

Timing of the Formation of the Limited Partnership Estate planners and business consultants warn that the Internal Revenue Service will not necessarily approve a family limited partnership if it is transparently obvious that the FLP was formed simply to skirt paying taxes. Family business owners who attempt to institute an FLP a few weeks before their death from some foreseeable illness will likely find their efforts blocked.

Divorce In most instances, a child's ownership of limited partnership shares will not be impacted by a divorce action by his or her parents, but business owners seeking to ensure protection for their child can take a couple of steps to provide additional insurance. Since limited partners (children) receive their shares as a gift and are not permitted to vote or otherwise exercise any authority in the partnership, the child's shares will not be considered part of the marital assets. Instead, they will remain the sole and separate property of the child. The key, say legal experts, is to make sure that the shares were never formally made part of the marital property.

Expense of Setting Up an FLP Establishing a family limited partnership can be somewhat expensive, although the price tag depends in large part on the size of the company, the value of its assets, the number of intended minority owners, and other factors. As of 2006, a family-owned company would need to have a value in excess of $2 million (or $4 million if a husband and wife team were partners in the business) before it would have any estate tax liability upon the death of its principal. If the value of the firm exceeds this threshold than the cost of setting up an FLP will likely be justified by the savings it will be able to generate by reducing the tax obligations due upon the transfer of the company.

Compatibility with Business FLPs are better suited to some businesses than others. The effectiveness of FLPs is greatest when used in family companies related to real estate or companies whose business relies greatly on capital assets. For service-oriented companies—firms that do consulting, computer networking, software development, landscaping, childcare, and/or small retailers, for example—the vehicle is not as beneficial since firms of this kind tend not to have large asset balances that they wish to protect from taxation.

Increased Risk of IRS Audits Although family limited partnerships can be very valuable, and their use is increasing, accountants and estate planning attorneys do caution family business owners that the use of an FLP will almost certainly lead to an IRS audit. This is not a reason to avoid forming an FLP but it does emphasize the need to do so with care and to keep thorough and complete documentation on its formation and activities.

A string of recent court cases in which the IRS successfully challenged the legitimacy of particular FLPs can provide guidelines to follow in forming FLPs that will withstand an IRS challenge. Gary Williams explains why FLPs based on true family-owned businesses are more likely to survive an IRS challenge in his Daily Record article entitled "Commentary: IRS Looks More Kindly on Family Limited Partnerships That Serve Business." He states that "commentators think you'll be on safest ground if the FLP includes an active family business or investment that requires active management by the FLP's partners, such as rental property."

Another measure that can be taken to improve one's likelihood of a successful audit outcome is to have the business appraised by an experienced, respected professional who can provide a solid valuation. For information on securing the services of an established appraiser, contact the American Society of Appraisers at (800) 272-8258.

Dissatisfaction Among Minority Owners Ironically, some family businesses find that FLPs actually spark difficulties between parents and their children, despite the formidable savings that such a plan can provide and the ultimate aim—reduced estate taxes upon succession—of the partnership. This is certainly not always the case; many families put together family limited partnerships that garner tax savings without a ripple of internal dissension or dissatisfaction. But it is a factor that can crop up, depending on the personalities and financial situations of the persons involved. When conflict arises it is usually caused by the minority owners who may feel constrained, unable to sell their shares and convert them into a liquid asset as desired. This feeling of not having control often manifests in the form of harassing the management, criticizing business decisions, lobbying for dividends, and generally causing unrest.

Need for Professional Guidance Establishing a family limited partnership is a complex estate-planning strategy, made even more complicated by the uncertainty of the regulatory environment. Subsequently, business owners are strongly encouraged to secure qualified legal and/or accounting help in setting up such plans.

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