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How An FLP Is Formed
How It Operates
Its Potential Advantages Or Disadvantages
Barry Zimmer ● Estate Planning Attorney ● The Zimmer Law Firm ● 513-721-1513
2 www.zimmerlawfirm.com
“Preserving a family business takes a good deal of careful financial and estate
planning, with the goal of keeping the business intact and financially healthy.”
Despite the rise of conglomerates and mega-stores throughout
the United States, family businesses are still alive and well in
America.
For most people, a family business is more than just a way to
earn a living – it is a legacy that needs to be protected and
preserved for future generations. Preserving a family business
takes a good deal of careful financial and estate planning, with
the goal of keeping the business intact and financially healthy.
It is therefore important to choose the right kind of entity for
your family business to form. The choices of entities can seem
overwhelming, and it’s wise to carefully analyze and consider
the future impacts your choices will have on your business.
Many family businesses form a family limited partnership, or
FLP. Read on to learn how an FLP is formed, how it operates,
and to learn about its potential advantages or disadvantages.
What Is a Family Limited Partnership?
When family members create an FLP, they join in a legal
partnership, becoming joint owners of family-owned assets,
such as those connected with a family-owned business. There
are two classes of partners: general and limited. In an FLP,
general partners are legally liable for the actions of the
partnership. Limited partners, meanwhile, are not legally
accountable for group actions, and their liability is limited to
the value of their partnership interest.
General partners have complete control over the partnership’s
operations, and share in profits and distributions. Limited
● ● ●
Family-owned businesses,
farms, ranches, and land
holdings are often the most
important and valuable
asset of a family’s legacy.
Sadly, less than 30% of
family businesses survive
the transition to the next
generation – a problem
that is sometimes but not
always caused by estate
taxes. More often
businesses fail after the
founders die due to issues
not related to taxes.
● ● ●
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partners still share profits and distributions from the FLP, but
do not have control over operations.
How Is a Family Limited Partnership Formed?
The first step in creating an FLP is to file paperwork with the
Secretary of State of the FLP’s home state. The name of the
filing may vary among states, but will be something like
“Articles of Limited Partnership” or “Certificate of Limited
Partnership”. The form and filing instructions will most likely
be available online.
When filing the initial form with the Secretary of State, you will
need to appoint a Statutory Agent. If your FLP is ever sued, the
Statutory Agent will receive initial lawsuit filings on behalf of
the partnership. If you form your FLP in a state where you
don’t live, there are companies who provide this service.
The next step is to execute a written partnership agreement.
Among other details, the agreement will name the general and
limited partners, and will assign them duties and
responsibilities. There will also be provisions addressing how
partnership interests can be sold, transferred, or encumbered,
all of which are necessary for keeping the FLP’s assets in the
family.
Therefore, unlike other partnership agreements, an FLP
agreement will usually forbid selling, transferring, or otherwise
encumbering a partner’s interests to anyone outside the family.
What Are the Advantages of a Family Limited
Partnership?
There are a number of advantages to forming an FLP, some of
which concern tax, transfer, and liability issues.
● ● ●
Creating a family limited
partnership can help you
meet such diverse goals as
estate planning and lawsuit
protection.
● ● ●
● ● ●
In an FLP, general partners
are legally liable for the
actions of the partnership.
Limited partners,
meanwhile, are not legally
accountable for group
actions, and their liability
is limited to the value of
their partnership interest.
● ● ●
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Liability and Control
Bringing future generations into a family
business can present some difficulties. The
next generation will have a lot to learn,
and they may not be ready to jump in and
make decisions right away. They may also
have doubts about taking on the
responsibilities and risks of running the
business. An FLP allows you to slowly and
incrementally bring a child or grandchild
into the business, limiting the individual’s
control over business decisions and
protecting him or her from liability if something goes wrong.
Transfer of Ownership
When a group forms an FLP, they also create
fractionalized interests in the partnership. Think of
these interests as the equivalents of stock in a
publicly traded corporation.
For example, imagine that Bob and Mary Johnson
own a family landscaping business. The business has
done well over the years and owns approximately
$12 million in assets. Among those assets are about
100 acres of land for growing trees, shrubs and
flowers; a warehouse for storing materials and
equipment; an office building; a small fleet of trucks
and other vehicles; and various other assets used in
the daily running of the business. The Johnsons also oversee some of the business’s financial
accounts.
When Bob and Mary create their FLP, all of these assets go into one “pot.” The general and
limited partners own shares or interests in the partnership. When the couple wishes to begin
transitioning their business to the next generation, they will only gift pieces or shares of the
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Specially designed Family Limited Partnerships, with a gifting plan, can reduce
estate taxation and still allow the business founder to maintain operating control.
FLP, instead of gifting interest in the business’s underlying
assets. As the heads of their business, Bob and Mary will
maintain control over the company’s operations - and
ownership of the general partner interests – until retirement or
death. The Johnsons might also choose to give yearly gifts of
interests to their children and/or grandchildren without
affecting their control over the company.
Tax Savings
This is where the FLP gets interesting. Both lifetime gifts and
gifts passed down at the time of death are subject to taxation.
However, taxpayers may still gift or bequeath assets up to the
current lifetime exclusion amount, set at $5.25 million for 2013,
and indexed for inflation. Annual gifts of $14,000 per donor per
donee (in 2013; indexed for inflation for future years) can be
made in addition to the lifetime exemption of $5.25 million.
Put simply, the value of the gifted asset or property determines
whether the gift is taxable or tax-sheltered.
As discussed above, partners in an FLP do not directly own
interest in the business’ assets; they own the FLP. Limited
partners in an FLP have less control over the business than
general partners, and they also have less control over the
interest they’ve received through the partnership. Therefore, a
limited partner’s interests are not as valuable as those of a
general partner. Due to this difference in value, limited partner
interests receive a “discount,” since somebody buying those
interests would pay less than the partnership interest’s pro rata
● ● ●
Partners in an FLP do not
directly own interest in the
business’ assets; they own
the FLP. Limited partners
in an FLP have less control
over the business than
general partners, and they
also have less control over
the interest they’ve
received through the
partnership.
● ● ●
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value, due to lack of control over partnership operations and
other factors.
Referring back to the example of Bob and Mary Johnson,
suppose that the landscaping business’ FLP owns $10 million
worth of assets. Their daughter, Sally, owns a 10% limited
partner interest. Since Sally is a limited partner, her share is
actually worth less than 10% of the partnership’s $10 million,
and this difference would still be relevant if Sally wanted to sell
her interest and cause the price to be less. This is the basis for
a valuation adjustment or “discount” when reporting the gift
on a gift tax return or valuing the assets on an estate tax return.
Of course there are details to be seen to, such as appraisals to
support the discounts.
Lawsuit Protection
An FLP can also provide valuable lawsuit protection. If a
partnership gets in legal trouble and is sued, the limited
partners are only at risk for what they have put into the
partnership in exchange for their partnership interests. Limited
partners’ personal assets are not at risk.
Similarly, if a limited partner gets sued for reasons not related
to the partnership, the judgment creditor cannot take over the
partner’s interest and force it to be sold to pay the claim. At
most, the creditor will get a “charging order,” which would
allow the creditor to receive FLP payments originally intended
for the limited partner. Since the general partner controls the
distributions to the limited partners, this puts the limited
partner / debtor in a better position to negotiate a favorable
settlement, or perhaps dissuade the judgment creditor from
even trying to collect.
The general partner, on the other hand, has unlimited liability.
That means if the partnership is sued, the judgment creditor
can collect against the general partner’s personal assets and
income to satisfy the FLP liabilities. This can be a serious risk.
Protecting Your Assets With The
Family Limited Partnership
Are you worried about being sued?
Well, you should be. It is reported
that there are 18 million lawsuits in
the United States each year.
However, that isn't the whole story.
Have you ever heard of the "deep
pocket" syndrome? The deep pocket
syndrome means that the person
claiming to have been harmed files a
suit against anyone even marginally
connected with the incident.
Click to Get Your Complimentary
Edition of the Report
“Protecting Your Assets With The
Family Limited Partnership”
7 www.zimmerlawfirm.com
But this risk is managed by making the general partner an
entity that protects the individual owner from liability. The
Limited Liability Company is often an ideal tool for this
purpose.
What Are the Disadvantages of a Family Limited
Partnership?
An FLP can be costly to set up initially, but the tax savings
generally far outweigh the cost of creation.
There has also been some speculation about the future of
discounts in FLPs. The American Taxpayer Relief Act of 2012 did
not include any significant changes to FLPs, so for now it
appears as though they are still an excellent option for anyone
who wishes to preserve and pass down a family business to
future generations. But it is anticipated that future tax
legislation proposals could include measures that restrict this
very powerful tax planning tool, so acting sooner rather than
later would make your new FLPs “grandfathered” under
currently existing law, rather than covered by the new law, as a
general rule.
Barry Zimmer engages in a Wealth
Care Practice. Specific services
include basic and advanced trust
planning; trust estate settlement;
probate estates; trust beneficiary
advocacy and representation; asset
protection; business organization;
business succession planning; and
pre-marital planning.
His goal is to make creating a Wealth
Care and Estate Plan the first step in
a relationship that is satisfying and
unlike a client's experience with any
other lawyer.
The Zimmer Law Firm 9825 Kenwood Road, Suite 201
Cincinnati, OH 45242 Phone: (513) 721-1513