For years, estate plannershave utilized the family limitedpartnership as a mechanismto preserve, protect and transferwealth. Despite changes instate taxation law and increasedscrutiny by the IRS, the familylimited partnership remains avaluable option for those seekingto protect and manage familyassets.
Just what is a family limitedpartnership? Simply stated, a family limited partnership is a limitedpartnership owned by members of the same family. It is designed topool together a family’s assets into one business. Under appropriatecircumstances, a family limited partnership can provide immensefederal gift and estate tax savings through the use of valuation discountsof the partnership interests.
Valuation discounts are meant to reflectthe reality of owning an undivided interest in a partnership. Apartnership interest is not liquid and typically cannot be easily solddue to restrictions in the partnership agreement. Because of thelack of marketability and transferability of the partnership interest,the interest is typically assigned a reduced value for federal tax purposes.The availability and extent of the valuation discount dependson the particulars of each situation and due to the level of scrutinyplaced on these types of partnerships by the IRS, proper care shouldtaken to support the valuation through the use of appraisals.
While family limited partnerships are probably best known forthese discounts, there are a number of less publicized, but equallyadvantageous, reasons to form a family limited partnership, such asasset protection, centralized management and flexibility.
Asset Protection: In a limited partnership, both state law andproperly drafted partnership agreements afford liability protectionto the assets held by the partnership. For example, as a general rule,a partnership interest cannot be seized or sold, unlike other nonexemptpersonal assets. Instead, where a creditor obtains a judgmentagainst a debtor, the creditor’s only recourse, with regard tothe partnership interest held by the debtor, is to seek a charging order.Under the charging order, the charging creditor becomes an assigneeof the debtor with respect to his or her partnership interest.However, the charging creditor is not entitled to become a partneror to exercise any rights of a partner, such as the right to vote onpartnership matters or inspect partnership records. This chargingorder limitation significantly limits the recourse available to a creditoragainst a debtor’s interest in a partnership.
Family limited partnerships may also lend some protection insituations involving divorce. For example, if a member of the familyis divorced, the partnership agreement may prevent the partnershipinterest from passing to the estranged spouse.
Centralized Management: Although tax savings and asset protectionare significant aspects of a family limited partnership, thereare also day–to–day reasons to form the partnership. A family limitedpartnership allows centralized management and investmentof a family’s assets while still allowing heads of families to maintaininvolvement with the partnership assets by virtue of their roles asofficers, directors or managers of the general partner.
Flexibility: In some circumstances, family limited partnershipsmay also provide more flexibility than other estate planning tools.For example, unlike an irrevocable trust, a property drafted familylimited partnership agreement can be amended to respond toevolving business, family and legal needs. A family limited partnershipalso permits a party to give an undivided fractional interest inpooled assets when making gifts rather than selecting and/or partitioningspecific assets. Larger sums of money and assets can alsotypically be managed more efficiently and economically.
For years, the family limited partnership was the modus operandifor estate and tax practitioners as opposed to other familybusiness structures, such as the family limited liability company.This was due in large part to the limited partnership’s exemptionfrom the Texas Franchise Tax. The recent introduction of the TexasMargin Tax now includes limited partnerships under its definitionof taxable entities which may be subject to tax. As a result, the questionof which type of family business structure to form is no longera simple decision. The decision of whether to form a family limitedpartnership or family limited liability company will depend on anumber of factors such as the nature and amount of the assets tobe placed in the partnership as well as the revenue expected to begenerated by the family business.
While the potential to enjoy tremendous tax savings has beenthe hallmark of the family limited partnership, there are a numberof valid business reasons for its formation in addition to the onesdiscussed in this article. It is highly recommended that you seek theadvice of a legal and financial professional when making the decisionto form a family limited partnership.
