A family limited partnership, or FLP, is a type of limited partnership that allows family members to pool money together in order to run a business project. It is owned by two or more family members who can buy shares in the venture for a potential profit. It also allows for tax-free transfers of wealth between family generations. FLPs have both pros and cons, so it is best to get a clear understanding of how they work to determine if it is the right fit for you, your family, and your business adventure.
How Do You Set Up a Family Limited Partnership?
In a family limited partnership, partners create a legal entity that will hold the assets they transfer into it. In exchange for transferring their assets into the FLP, the partners receive general and limited partnership shares. If the family owns a business, the FLP can also hold business assets.
An FLP provides for greater asset protection from creditors and gives its members some flexibility in terms of taxation options, since they can transfer assets between themselves without taxation. Members are either limited partners or general partners. General partners are usually senior family members with higher levels of wealth who own the largest shares of the business and retain day-to-day management responsibilities. Limited partners have no management responsibilities and purchase shares of the business in exchange for potential dividends or profits the FLP may generate.
What Has the IRS Said About FLPs?
The IRS has tightened its scrutiny on family limited partnerships in recent years, due to its obvious tax advantages. Recent changes allow the IRS to collect income tax directly from the FLP (instead of its partners) if the FLP is determined to have underreported income. This may result in a higher tax bill, as an FLP pays tax at the highest individual or corporate rate.
The new rules have the potential to shift tax liability to the younger generation and cause rifts in the family, if proper planning is not in place. The IRS is also auditing FLPs more aggressively and testing their validity. FLP owners must seek the help of a professional to ensure the terms of their partnership will not open a window for IRS audits and challenges.
How Do I Know if Creating an FLP Is Right for Me?
The creation of a family limited partnerships is a process that should be done carefully to protect your assets without triggering an audit or a challenge from the IRS. While it can offer benefits, such as ease of transition of your assets to the next generation and tax savings, it comes at a significant cost and requires yearly reporting in order to not be classified as an investment by the IRS. The best you can do is to consult a qualified professional to understand the details of forming an FLP and also to see if it is right for you.
Oren Ross & Associates has helped many families to confidently make the right choices to protect their businesses and safeguard their estate for the next generation. Contact our office at (404) 436-1752 to see how we can assist you protect your legacy.