What Is a Family Limited Partnership?
An arrangement in which family members pool money to run a business project is known as a Family Limited Partnership (FLP). Family members separately buy units or shares of the business and can benefit in proportion to the number of shares they hold, as summarized in the partnership operating agreement.
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Quick overview
– A family limited partnership is a holding company or business owned by two or more family members.
– Each family member can buy shares in the venture for a potential profit within a family limited partnership (FLP).
– In an FLP, there are two types of partners – general partners and limited partners.
– Family Limited Partnerships are often established to preserve the generational wealth of the family, authorizing tax-free transfers of assets, real estate, and other wealth.
Understanding the Family Limited Partnership
FLPs have two types of partners. General partners are responsible for day-to-day management tasks such as overseeing all cash deposits and investment transactions, they usually own the largest share of the business. If outlined in the partnership agreement, the general partner may also take a management fee from profits.
On the other hand, limited partners have no management responsibilities. They rather buy shares of the business in exchange for interest, dividends, and profits the Family Limited partnership may generate.
Depending on the nature of the business FLPs vary. For instance, assume an individual wants to start a luxury apartment venture. They expect the project to cost $1 million, including working capital and take in about $200,000 in cash each year before taxes and interest on mortgage payments. They calculate that they will require no less than a 50% down payment of $500,000. In this case, family members get together, and they all agree to establish a Family Limited Partnership that will issue 5,000 limited partnership shares at $100 each for a total of $500,000. According to the limited partnership agreement units cannot be sold for at least 6 years, and the Family Limited Partnership will pay 70% of cash earnings in the form of dividends.
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By contributing $50,000 to the FLP, as the general partner, the original individual who made the calls buys 500 shares. The remaining shares are bought by family members. Now, each family member owns a stake in a Family Limited Partnership starting at $500,000. Next, to start the $1 million luxury housing project, the general partner might get a first mortgage loan for the rest of the $500,000.
The Family Limited Partnership then rents out these apartments to tenants and starts taking income from rent. Profits and dividends are distributed as the mortgage is paid off, and each family member grows wealthier.
Advantages of Family Limited Partnerships
There are some gift and estate tax advantages of an FLP. Several families establish Family Limited Partnerships to pass wealth down to generations while guaranteeing some tax protections.
Every year up to the annual gift tax exclusion individuals can gift FLP interests tax-free to other individuals.
Imagine, a couple accumulated savings worth $7 million. They have six children and eight grandchildren. The couple makes a decision to transfer the whole amount to the FLP they established. Per year, they gift $40,000 worth of FLP interests to each of their 14 kids or grandkids. This means the couple can transfer $560,000 worth of FLP interests gift-tax-free every year [assuming the gift tax exclusion stays the same].
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Future Returns Excluded from Estate Taxes
Additionally, these assets effectively leave the couple’s estates, as far as the IRS is concerned, so that any future returns would be excluded from estate taxes. The couple’s children and grandchildren would profit from any dividends, interest, or profits generated from the Family Limited Partnership—thereby preserving wealth for future generations.
In the partnership agreement to protect these gifts from being squandered or mismanaged the couple, as general partners, can set stipulations. For instance, they can develop a rule stating that until the beneficiaries reach a specific age gifted shares cannot be transferred or sold. The shares can be transferred through a Uniform Transfers to Minors Act [UTMA] account if any beneficiaries are minors.
Families should consult qualified accountants and tax professionals before establishing an FLP because the structure of FLPs and the tax laws that govern them are complicated.