A family limited partnership (FLP) is formed to manage and control jointly-owned family property. FLP is not a legally recognized term by any state or by the IRS. Instead, it is a term used by firms to explain the process of transferring assets into a business form without traditional business intentions in mind.
When you agree to an FLP, you place your assets into a business and therefore waive control and ownership of the assets. All the requisites of a limited partnership must be followed in order to create a valid family limited partnership. Upon formation of the FLP, the assets of the family are assigned or transferred into the FLP for ownership, management, and control. In most FLPs, the parents are the general partners with a 1% interest, while the children and siblings share the remainder as limited partners. Thus the parents' exposure to risk or loss of property held by the FLP is greatly reduced. Even if a charging order is obtained by a creditor, the partnership can limit distributions (for legitimate purposes) to reduce exposure.
A family limited partnership can also have a dramatic effect on gift and estate taxes. By transferring assets to an FLP, general partners can use valuation discounts to lower values. With lower valuations, the amount of tax imposed can be substantially reduced. For instance, if you set up an FLP with $1,000,000 in assets with each of your two children holding a 25% limited ownership in the company, they may eventually own $250,000 in the company, but because the assets will be delayed, the actual value will be judged as less. Because the value is held to be less, the original creator of the FLP will pay fewer gift taxes as assets are transferred to the limited partners.
Family limited partnerships are not a legally recognized entity and do not meet the general definition of a business (an entity created to make money). Because of this, many family limited partnerships are coming under scrutiny by the IRS and being considered holding companies established for tax evasion purposes. If this is found to be true, the parties involved will be liable for the full gift tax amount of any transfers.
If you are considering using a family limited partnership as a form of asset protection, do so with a specialized legal company. Consider all other possible options before using this form of estate management. Alternative options like irrevocable trusts can offer the same benefits and are legally recognized forms of wealth management. Finally, monitor current policy regarding family limited partnerships, as this form of estate planning may be held by either a state or federal government to be completely illegitimate, which will result in mandatory dissolution.