Could the Use of an FLP Lead to the Next Great American Success Story?

Elizabeth Cody

Are you thinking of starting a business but do not have enough capital?  Consider creating a family limited partnership (FLP).  By pooling funds with family members you can open a business not otherwise possible due to lack of money or experience.  In 1956, Warren Buffett pooled funds totaling just $105,000 with seven family members, of which a mere $100 was his own money, to create what is now one of the great American success stories.

An FLP is also a powerful tool utilized by high net worth families to move wealth from one generation to another.  It allows the transfer of an ownership interest to other family members, the retention of business control and helps ensure continued family ownership of the business. Typically, senior family members contribute assets such as existing businesses and income-producing assets in exchange for small general partner interests and a large limited partner interest.  The General Partner(s), typically one or both parents, retain control over decisions and distributions of income or capital, and gives all or a portion of the limited partner interests to their children and grandchildren, or trusts for their benefit. Transferring limited partner interests to family members reduces the taxable estate of senior family members, shifts some of the business income and deflects growth to the younger generations.  At death, only the value of one’s ownership interest in the partnership will be included in the gross estate.  Benefits include:

· Shares (LP interests) can be gifted to family members over the years, thus taking advantage of annual gift tax exemptions.

· A valuation discount applies to transfers of limited partnership interests through gifts or sales to descendants due to the characteristics of lack of marketability and control.

· Assets held in the FLP are not owned by individual partners.  Therefore, these assets cannot be attached by the personal creditors of a partner and can be protected from claims of a spouse in the case of divorce.

· The FLP can be used to encourage entrepreneurship in the younger generations.  For example, should a son or daughter wish to create a new company, he or she could request a loan or distribution from the partnership to start the new venture.

· Pooling investments together into an FLP can lower legal, accounting and investing costs. It can also allow junior family members to participate in private placement investments available only to "accredited investors" that otherwise might not be available to them individually.

Proposed regulations by the Treasury Department and the IRS were released in August 2016 which would impact estate planning for owners of family controlled entities.  If they become final, it would dramatically limit the use of valuation discounts for FLPs or other family business transfers where the family will retain control before and after the gift or bequest takes place. 

Many practitioners now doubt the likelihood of these proposed regulations becoming finalized given the results of the 2016 election.  With Republican control of both houses of Congress and the Executive branch, these proposed regulations may languish without ever becoming final.

So, until any proposed regulations become effective, FLPs are good planning tools for the efficient use of a family's lifetime gift tax exemption and the senior generation's annual gift tax exclusions. A gift tax exemption is the total amount that can be given away by an individual over his or her lifetime to any number of people free from gift taxes.  For 2017, the exclusion is $5,490,000 per individual or $10,980,000 per couple.

If you are contemplating the creation of an FLP, consult with your tax and legal advisors to determine if this vehicle makes sense for your wealth transfer plan.

This information has been developed internally and/or obtained from sources that Sand Hill Global Advisors, LLC (“SHGA”), believes to be reliable; however, SHGA does not guarantee the accuracy, adequacy or completeness of such information nor do we guarantee the appropriateness of any investment approach or security referred to for any particular investor. This material is provided for informational purposes only and is not advice or a recommendation for the purchase or sale of any security. This information reflects subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. This material reflects the opinion of SHGA on the date made and is subject to change at any time without notice. SHGA has no obligation to update this material. We do not suggest that any strategy described herein is applicable to every client of or portfolio managed by SHGA. In preparing this material, SHGA has not taken into account the investment objectives, financial situation or particular needs of any particular person. Before making an investment decision, you should consider, with or without the assistance of a professional advisor, whether the information provided in this material is appropriate in light of your particular investment needs, objectives and financial circumstances. Transactions in securities give rise to substantial risk and are not suitable for all investors. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of SHGA.