Family Limited Partnerships for the Next Generation
About 75% of family businesses in the United States have been family-run for two or more generations.1 One challenge faced by family-run businesses involves business continuation.
When business owners fail to consider that federal and state estate taxes could be due upon their passing, the money needed to cover the bill may not be available, and their heirs may have no choice but to liquidate the family’s business. On the other hand, starting the succession planning process sooner rather than later could help reduce the estate tax burden and alleviate family strife.
A family limited partnership (FLP) is a legal agreement that enables business owners and their heirs to address tax issues, business succession, and estate planning needs all at once. Specifically, business owners who want family members to inherit their businesses in the future could use FLPs to transfer assets out of their estates during their lifetimes. Moreover, they might begin this process many years before they intend to give up operational control.
Estate Tax Threat
The IRS calculates the estate tax due on an individual’s gross taxable estate by adding the value of all owned assets, including a home and/or a business, and subtracting any applicable exemptions. Even if a business valuation falls well below the federal estate tax exemption level ($5.45 million in 2016), the family might not be entirely out of the woods, especially if they live in a state that has an estate tax or an inheritance tax with a lower exemption amount.
If an FLP is set up for the benefit of limited partners such as a spouse and children, a general partner (or a corporation or limited liability company controlled by the general partner) may gift ownership shares in installments that conform to the $14,000 annual gift tax exclusion (in 2016).
Gifts of limited partnership interests can also be discounted up to 30% or more from fair market value, which may provide an opportunity to take even greater advantage of tax-free gifts. For example, a limited partner may be able to gift approximately $20,000 worth of property or business shares that are currently valued at $14,000 for gift tax purposes.2 Of course, each situation is different, and actual results will vary.
Setting up a family limited partnership can involve complex tax rules and regulations, as well as up-front costs and ongoing expenses. Be sure to consult with your tax and estate planning professionals.