One of the most popular Estate Planning techniques since the 1990’s involves the establishment of a Family Limited Partnership (FLP). By transferring assets to such a Partnership, a senior family member may take advantage of valuation discounts for Gift and Estate Tax purposes. The FLP is a means of transferring assets to lower generations of family members, at a reduced transfer tax cost.
Property such as stocks and bonds, real estate or other limited partnership interests, may be transferred into a new partnership entity. Transfer of assets to a partnership may generally be accomplished Income Tax-free.
A limited partnership contains both Limited Partner interests and General Partner interests. The General Partner is in charge of managing the partnership assets and the day-to-day affairs of the Partnership.
The Limited Partners have no say in or control over the Partnership’s operations, but merely possess a right to a percentage of partnership profits. Initially, the transferor holds a majority of the partnership interests as a Limited Partner. The transferor then makes gifts of his or her Limited Partner interests to children, grandchildren, and/or Trusts for their benefit.
Gifts of Limited Partner interests are discounted for their lack of marketability, and their status as minority interests.
These discounts are based on the lack of a ready market to determine the value of Family Partnership interests, and also the Limited Partner’s lack of control over the management of the partnership.
These discounts may result in the Gifted Limited Partner interests being valued at ten percent (10%) to forty percent (40%) less than the value of the underlying partnership property.
For example, if a twenty-five percent (25%) discount is utilized, a gift of Limited Partner interests which equal seventeen thousand three hundred thirty-four dollars ($17,344) worth of underlying property is valued at only thirteen thousand dollars ($13,000), thereby qualifying for the Annual Gift Tax Exclusion.
This gifting process may be repeated annually. In addition, the transferor may utilize his or her Unified Credit to make gifts of larger Limited Partner interests. At the death of the transferor, his or her remaining partnership interest may also be discounted for Federal Estate Tax purposes.
In order to maximize the use of valuation discounts, a professional appraiser should be retained.
A well-documented appraisal provides support for valuation discounts in case such are questioned by the Internal Revenue Service, which is likely based upon recent Internal Revenue Service announced protocol and procedure.
The transferor, either alone or with one or more individuals, usually serves as General Partner of the FLP. Thus, the transferor may control the partnership assets for the remainder of his or her lifetime.
It is generally recommended that there be one or more General Partners in order to maximize Federal Estate Tax discounts at the death of a General Partner who also owns a Limited Partner interest.
In that case, the transferor may serve as Managing General Partner, to ensure the retention of control.
A partnership is a “pass-through” entity for Income Tax purposes. Thus, there is no tax due at the entity level (although an informational tax return is required to be filed). Rather, the individual partners are liable for Income Tax on their proportionate shares of partnership income. Partnership income is allocated to the partners annually, based on their percentage interests.
Thus, the Family Limited Partnership is a means of shifting income to family members who may be in lower tax brackets than the transferor.
Also, the General Partner may be given the ability to decide how much income is actually distributed to the individual partners. In this way, the transferor may gift an asset (partnership interest) to children and grandchildren, without allowing them to receive all of the income earned from such asset, currently.
A Florida Limited Partnership must file a Certificate of Limited Partnership with the Florida Department of State. An initial filing fee is required, currently one thousand dollars ($1,000). In addition, an Annual Report is required to be filed, together with a modest annual filing fee (namely, four hundred eleven dollars and twenty-five cents ($411.25) filing fee and eighty-eight dollars and seventy-five cents ($88.75) supplemental fee, or five hundred dollars ($500.00 total).
Since its repeal in 2006, intangible personal property (i.e., stocks, bonds, notes, etc.) held in a Family Limited Partnership will not be subject to the Florida Intangible Personal Property Tax.
Consider the following example:
John Doe contributes stock with a market value of eight hundred twelve thousand five hundred dollars ($812,500) to the Doe Family Limited Partnership.
John Doe retains a two percent (2%) interest as General Partner and forty-five percent (45%) interest as Limited Partner. John gives his wife, Jane, a forty-five percent (45%) Limited Partner interest, (which can be accomplished Gift Tax-free using the Marital Deduction) and gives each of his two children and two grandchildren two percent (2%) Limited Partner interests.
Each two percent (2%) interest, without any discount, would be valued for Gift Tax purposes at sixteen thousand two hundred fifty dollars ($16,250). However, by applying a twenty percent (20%) valuation discount, each gift is valued at thirteen thousand dollars ($13,000) for Gift Tax Purposes, equal to the Annual Exclusion amount for such gifts.
Thus, John would have shifted sixty-five thousand dollars ($65,000) of his assets to his children and grandchildren with no Gift Tax cost.
Moreover, such amounts will not be subject to Federal Estate Tax in John’s Estate.
Jane may also gift her Limited Partner interests, with the same Gift and Estate Tax benefits. Thus, John and Jane, together, may transfer one hundred thirty thousand dollars ($130,000) of assets annually with no Gift Tax.
In addition, each child and grandchild would thereafter be entitled to two percent (2%) of all Partnership distributions, which may be made at the discretion of the General Partner. Gifts in later years would further reduce the value of John’s Partnership interests, while increasing the interests of his children and grandchildren.
At John’s death, his remaining interest may be discounted for Federal Estate Tax purposes.
Similar Federal Estate Tax savings may be achieved through the use of a Limited Liability Company.
Caution should be exercised in using a Family Limited Partnership because recent Court cases brought by the Internal Revenue Service successfully challenged discounts sought by Estates of taxpayers who established and funded the Family Limited Partnership shortly before death, calling the same a sham transaction.