Could My Family Benefit
from a Family Limited Partnership?
Effective estate planning
should address wealth transfer from a practical and cost-effective approach. One
estate planning strategy that families with closely held businesses should
consider is the family limited partnership.
What Is a Family
Limited Partnership?
A family limited
partnership is a partnership agreement that exists between family members who
are actively involved in a trade or business. The partnership divides rights to
income, appreciation, and control among the family members, according to the
family’s overall objectives. Under family partnership rules, the “family
business” can include real estate or investments.
How Is This Arrangement
Achieved?
Under the most common form
of family partnership, you would begin by creating general and limited
partnership interests in your business. Once the partnership is established, you
then gift the limited partnership interests to your children.
By holding the general
partnership interest, you are considered the “general partner” and maintain
control over the enterprise. Your children are the “limited partners,” and
the limited partnership interest lets them share in the ownership of your
business as well.
A Sound Strategy for
Transferring Ownership
A family limited
partnership enables you to provide your children with an interest in your
business while achieving many goals. First, you can gauge whether or not they
possess suitable ownership abilities by involving them in the business. Second,
it removes the asset from the parents‘ estate, thus lowering the estate tax
liability, if properly executed. In addition, you can transfer the limited
partnership interests in increments over time, resulting in a gradual,
systematic transfer of ownership. Finally, and perhaps most importantly, there
may be immediate income tax benefits.
Estate Tax Savings
The interests transferred
to your children, including all appreciation since the transfer, escape
inclusion in your estate when you die. Only the value of the taxable gift(s)
will be included. This can result in estate tax savings down the road.
The Benefits of
Leverage
By giving the partnership
interests in increments over time, you can take maximum advantage of the $10,000
annual gift tax exclusion. The exclusion increases to $20,000 if you’re
married and if each spouse elects to give the maximum amount. The gift tax
exclusion is indexed for inflation.
In addition, “minority
discounts” — allowable reductions to the value of the gift because it is a
minority interest — can lead to greater leverage of the annual exclusion and
the unified credit. For instance, you may be able to discount the value of the
gift up to 30 percent or more. However, in order for the discount to be valid,
there must be a legitimate business reason for the partnership.
Generally, your wish to
keep the business in the family is a legitimate reason to set up a partnership
agreement — as long as you are joined together for the purpose of enterprise
and not just to avoid taxes.
Income Tax Benefits
Aside from the estate
planning advantages, the family limited partnership can result in substantial
income tax savings. By including your children as partners and sharing
partnership income with them, total family taxes may be reduced.
You should be aware,
however, that if the income is unearned and the recipient is under age 14,
“kiddie tax” rules will apply.
Other Opportunities Can
Serve Your Family
In addition to family
limited partnerships, there are other arrangements that can serve family
interests:
Family partnerships are
arrangements under which each partner must play a role in the management and
day-to-day operations of the business. Many of the benefits are similar to that
of a limited partnership, but the family members accept more liability and will
be more involved in the business. As managing partner, however, you must always
receive a minimum income share that is proportional to the value of your
services.
In addition, minors
typically cannot be partners unless there is someone who controls the interest
for the minor.
Investment partnerships
are partnerships that hold nonbusiness assets such as securities and real estate
that are likely to grow in value. Families can base a limited partnership on an
investment partnership. In some cases, however, the arrangement would be
considered an investment company, and gains and losses will be realized on the
transfer of property to the partnership. Normally, under partnership rules,
gains and losses are not realized when transferred to the partnership.
Seek Professional
Guidance
The benefits of the family
limited partnership can be significant. But they can only be realized if the
arrangement is valid under the requirements of the IRS. Consult a qualified
legal or tax advisor if you think your family could benefit from a family
limited partnership.
© 2003 Emerald Publications
