During the past decade many individuals have sought to lessen potential gift and estate tax liability by establishing what is popularly known as a “family limited partnership” (an “FLP”) to hold business assets. As a tax planning mechanism, the FLP is used because the limited partnership interests carry with them no rights to manage the partnership and because there is no market for such a limited partnership interest. As a result, a high net worth family member who transfers limited partnership interests can legitimately assign a lower value to these assets when transferring them to family members. When done properly and in the right circumstances, this results in a lower gift or estate tax.
The initial planning and drafting of documents is only half the process. Once the FLP is set up, the assets obviously have to be transferred, and, thereafter, annual “house-keeping” issues need to be attended to. Failure to attend to these housekeeping issues can result in the FLP being disregarded by the IRS – meaning that the FLP assets are considered part of the decedent’s estate and the tax savings thought achieved are effectively lost.
These housekeeping items include the following:
1. Separate accounts for the general partner and the FLP itself should be established and funded; the general partner and the FLP should have separate tax ID numbers, and necessary tax returns should be filed.
2. The books and records of the FLP and the corporate general partner must be maintained. This applies both to the “minute books” documenting all corporate and partnership actions and the financial records.
3. FLP assets should not be used to pay personal obligations of the decedent, any limited partner, any shareholder of a corporate general partner, etc.
4. The limited partnership agreement (the “LPA”) must be followed. Distributions should be made only to the parties specified in the LPA and in amounts and at the times allowed by the LPA.
A meeting with your tax advisor/attorney should be conducted yearly to address whether all of the above guidelines are being respected. You and your advisor should discuss, among other things, the propriety of any distribution from the partnership, the transfer of limited partnership interests, whether all notices required by tax law and state law have been given and whether all annual meeting/documentation requirements have been met.