Family Limited Partnerships & Estate Planning: Key Considerations for High-Net-Worth Families

A Family Limited Partnership (FLP) is a specialized legal structure designed to help families manage and protect their assets while facilitating wealth transfer across generations.

With many provisions of the Tax Cut & Jobs Act (TCJA) set to expire at the end of 2025, high-net-worth individuals and families are proactively seeking ways to mitigate their potential tax burden. One of the most significant changes anticipated is the reduction of the increased estate tax exemption, which is expected to drop by more than half on January 1, 2026, unless Congress acts to extend it.

As of 2024, estates worth up to $13.61 million are exempt from federal estate taxes. However, once this provision of the TCJA sunsets, the exemption amount will revert to its pre-TCJA level of $5.6 million per individual, adjusted for inflation.

For families aiming to preserve their wealth in light of this potential change, a Family Limited Partnership (FLP) can be a powerful estate planning tool. Beyond shielding your hard-earned assets from potential threats, FLPs offer a tax-efficient method for transferring wealth to future generations.

Despite their complexity, FLPs can be a cornerstone of a comprehensive estate plan for those who understand their potential. By leveraging the unique benefits of FLPs, you can plan your future, reduce your overall tax burden, and smoothly transfer wealth while maintaining control. However, it’s essential to grasp the rules and nuances of FLPs to maximize this often-overlooked estate planning strategy.

What is a Family Limited Partnership?

A Family Limited Partnership (FLP) is a specialized legal structure designed to help families manage and protect their assets while facilitating wealth transfer across generations. At its core, an FLP consists of two types of partners: general partners and limited partners.

General partners are typically the senior family members who maintain control over the partnership’s assets and decision-making processes. They’re responsible for the day-to-day management of the FLP and bear unlimited liability for the partnership’s debts and obligations.

In contrast, limited partners – often younger family members or trusts set up for their benefit – have a financial stake in the partnership but limited involvement in its management. Their liability is restricted to the amount of their investment in the FLP.

Consider the following example:

John and Mary Johnson own a successful real estate business. As part of their estate plan, they establish a Family Limited Partnership (FLP) and transfer their $10 million property portfolio into it, retaining 2% ownership and full management control. Their children, Sarah and Michael, become limited partners, each receiving a 49% interest.

As general partners, John and Mary make all investment decisions and manage the properties. Over time, they gradually gift additional partnership interests to Sarah and Michael, thereby reducing their potential estate tax liability. Meanwhile, Sarah and Michael benefit from the income the properties generate without involving themselves in day-to-day operations.

If the FLP faces a lawsuit, John and Mary’s personal assets outside the FLP are protected, and Sarah and Michael’s liability is limited to their investment in the FLP. This structure allows the Johnsons to preserve their family’s assets, reduce their overall tax burden, and smoothly transfer wealth while maintaining parental control.

Key Benefits of FLPs in Estate Planning

Family Limited Partnerships (FLPs) offer several key benefits in estate planning.

First, FLPs provide robust asset protection. By transferring assets into the partnership, they can be shielded from personal creditors, offering a layer of security in case of financial difficulties, lawsuits, or even divorce proceedings.

From a tax perspective, Family Limited Partnerships (FLPs) offer several advantages that can lead to significant tax savings and efficient wealth transfer:

• Gift Tax Savings. When transferring partnership interests to family members, the value of these interests can be subject to valuation discounts for lack of marketability and control. These discounts effectively reduce the taxable value of the gifts, allowing for larger transfers within the confines of the annual gift tax exclusion and lifetime exemption limits.
• Estate Tax Reduction. FLPs help reduce estate taxes by fragmenting ownership among family members. By transferring limited partnership interests to children or other heirs over time, the overall value of your taxable estate declines. Valuation discounts can further reduce the effective estate tax burden.
• Income Tax Benefits. FLPs can offer income tax benefits depending on their structure and the assets they hold. For instance, the FLP can allocate income it generates among the partners, potentially shifting income to family members in lower tax brackets. The FLP can also take advantage of various deductions and tax treatments available to businesses, potentially reducing taxable income at the partnership level.

Another appealing aspect of FLPs is the ability to maintain control over family assets while gradually transferring wealth to younger generations. This flexibility ensures that experienced family members can guide the partnership’s direction, even as ownership transfers to limited partners.

Lastly, FLPs can be invaluable for business succession planning. They provide a framework for the smooth transition of family businesses, helping to preserve the family’s legacy and ensure continuity across generations.

Potential Drawbacks and Considerations

While Family Limited Partnerships (FLPs) offer numerous benefits, it’s important to consider potential drawbacks before deciding if this structure is right for your estate planning needs.

One of the primary considerations is the complexity and cost associated with setting up an FLP. Establishing this legal entity requires careful planning and typically involves attorneys, accountants, and potentially other financial professionals.

This expertise comes at a price, generally ranging from $8,000 to $15,000 or more depending on where you live and the complexity of the partnership. Furthermore, you’ll likely be responsible for paying annual operating costs, tax filing expenses, and appraisal fees.

FLPs also come with ongoing administrative requirements, including maintaining separate financial records, filing annual tax returns, and holding regular partnership meetings. Failing to properly manage these responsibilities could jeopardize the legal and tax benefits of the FLP.

Another drawback of FLPs is that they can attract scrutiny from the Internal Revenue Service (IRS). The agency pays close attention to these structures, particularly when they’re used primarily for tax avoidance rather than legitimate business purposes, making it essential to properly structure and operate your FLP.

Properly valuing the assets you transfer into the FLP is also critical as incorrect valuations can lead to tax issues and potentially invalidate some of the intended benefits. Professional appraisals are often necessary, especially for complex or unique assets.

Lastly, keep in mind that in some states, including California, transferring real property to an FLP can trigger a reassessment of the property tax. Be sure to consult a tax professional to avoid unintended tax consequences.

Despite these challenges, many families find that the benefits of FLPs outweigh the drawbacks. By working closely with experienced professionals and maintaining meticulous records, you can navigate these potential pitfalls and maximize the benefits of your FLP.

Who Should Consider a Family Limited Partnership?

High-net-worth families are often prime candidates for FLPs. If you have substantial assets that you want to protect and eventually pass on to your heirs, an FLP could provide valuable benefits. This structure can be particularly useful if you’re looking to minimize estate taxes or protect assets from potential creditors.

Family business owners might also consider an FLP. If you’ve built a successful business and want to keep it in the family, an FLP can provide a framework for gradually transferring ownership to the next generation while maintaining control. It can also offer protection for business assets and facilitate a smooth succession plan.

Those with complex estate planning needs may find FLPs especially beneficial. If you have a diverse portfolio of assets, multiple heirs with different levels of financial acumen, or specific goals for how to manage and distribute your wealth, an FLP can offer the flexibility and control you need.

It’s important to note that the benefits of FLPs aren’t limited to the ultrawealthy. They tend to be most suitable for individuals or families with substantial assets and a long-term perspective on wealth management.

Steps to Establish a Family Limited Partnership

Establishing a Family Limited Partnership (FLP) involves several key steps to ensure it’s set up correctly and provides the intended benefits.

1. First, be sure to consult with experienced legal and financial professionals. FLPs are complex structures with significant legal and tax implications. Your team should include an estate planning attorney, a tax advisor, and possibly a financial planner.
2. Next, work with your advisors to determine the partnership structure and decide which assets to include. This involves choosing general and limited partners, determining ownership percentages, and selecting assets to transfer into the FLP.
3. Once the structure is in place, your attorney will draft the necessary legal documents and file them with the appropriate state authorities. These typically include a partnership agreement, which outlines the rights and responsibilities of all partners, as well as any transfer documents for the assets being moved into the FLP.
4. The last step is funding the partnership. This involves valuing and transferring the assets into the FLP’s ownership.

Remember, establishing an FLP is just the beginning. Ongoing management and compliance are essential to maintain its benefits and legal standing.

In addition, clear communication with family members is vital throughout this process. Everyone involved should understand the purpose of the FLP, their roles within it, and the long-term vision for family wealth management.

Best Practices and Caveats

While a Family Limited Partnership (FLP) can offer numerous benefits, it’s crucial to approach them with caution and adhere to best practices to avoid potentially costly pitfalls.

To steer clear of issues with the IRS, make sure your FLP has a legitimate business purpose beyond tax savings. You’ll need to maintain proper documentation, hold regular meetings, and avoid commingling personal and partnership assets. Proper valuation of the assets you transfer into the FLP is also critical to withstand IRS scrutiny.

Additionally, if you decide to dissolve an FLP after creation, be aware that it can be complex and potentially costly. You may face tax consequences, especially if significant appreciation has occurred since the FLP’s formation. Always consult with legal and tax professionals before making such a decision.

Alternatives to FLPs

While FLPs are powerful tools, they’re not always the best choice. Alternatives like trusts, Limited Liability Companies (LLCs), or direct gifting strategies might be more suitable in certain situations. For example:

• Trusts might be preferable if your primary goal is to provide for minors or individuals with special needs.
• LLCs could be a better option if you’re seeking simpler management structures or greater flexibility in profit distribution.
• Direct gifting might suffice if you have a smaller estate and simpler transfer goals.

Remember, estate planning is not one-size-fits-all. What works best for one family may not be ideal for another. The key is to understand your options and make informed decisions that align with your goals and values.

SageMint Wealth Is Here to Help

Family Limited Partnerships can offer a range of benefits for estate planning, including asset protection, tax advantages, and controlled wealth transfer to future generations. However, it’s important to keep in mind these are complex entities that require careful consideration and experienced guidance.

If you have significant assets or a family business and are looking for an effective way to manage and transfer wealth, exploring FLPs as part of your comprehensive estate planning strategy could be worthwhile. At SageMint Wealth, our team of financial professionals can help you explore potential solutions for your family and long-term goals. Contact us to learn more and begin your financial journey.

SageMint Wealth and LPL Financial do not provide legal advice or services. Please consult your legal advisor regarding your specific situation.