One of the most popular estate planning tools is the family limited partnership. It allows a family to divide up family assets, while allowing Mom and Dad to maintain control. It allows a family to shift income from high tax bracket individuals to lower tax bracket individuals. It is a great asset protection tool. There are many family limited partnership estate planning strategies.
Family Limited Partnership Estate Planning Strategy 1: Division of Family Assets
Families with large pieces of property or bigger assets, including business stock, can find themselves with an estate tax problem. By dividing the asset up and “giving” it to family members the value of the asset in Mom and Dad’s estate can be reduced. Gift tax laws kick in, because the family members are actually being gifted their interest in the asset.
Actually, the way it works is the asset is transferred from Mom and Dad into the family limited partnership. In exchange for the transfer of the asset into the family limited partnership, Mom and Dad will receive all of the general partnership and all of the limited partnership interests in the family limited partnership. Mom and Dad then “give” limited partnership interests to their family members.
Provided the gifts of family limited partnership interests are under the “annual exclusion amount,” the gifts are not subject to gift taxes.
The advantage of dividing up a large asset in a family limited partnership is the central control of the limited partnership. By law, the general partner(s) of the family limited partnership control the assets of the family limited partnership. Limited partners have no say in the management of the limited partnership assets.
Thus, the parents maintain control over the asset and are still able to give away value to the children and grandchildren.
Family Limited Partnership Estate Planning Strategy 2: Shifting Income
Once limited partnership interests are given to the family members, they become responsible for paying taxes on their share of the partnership profits. Of course, they are also responsible on their tax returns for any losses allocated to them.
Note that even though they are responsible for losses, limited partners are not subject to any liabilities of the family limited partnership. The maximum exposure a limited partner has to liabilities and creditors of the limited partnership is the value of the limited partner’s limited partnership interests.
When the profits are “shifted” to the limited partners the family can save taxes, because it is assumed that the limited partners are in lower tax brackets than Mom and Dad would be in. This is a good way to “help” family members who are in lower tax brackets while saving the family taxes as a whole.
If money is shifted to kiddies (children under 23) a special tax, the Kiddie Tax, kicks in. Effectively, only about $3.000 can be taxed to the kiddies and have a good tax savings. The IRS has been hell bent on stopping shifting, so they keep making the kiddie tax more restrictive.
Note that if you are supporting older members of the family, the kiddie tax doesn’t apply.
Family Limited Partnership Estate Planning Strategy 3: Asset Protection
Asset protection in family limited partnerships has a hole in it. The general partner(s) is personally liable for all the debts and liabilities of the limited partnership. Limited partnerships don’t have a “corporate shield.”
Limited partners are only liable up to the amount of their limited partnership interests.
A lot of family limited partnership estate planning involves making a corporation or an LLC (limited liability company) the general partner. That way an individual isn’t liable as the general partner. But, this requires two entities, the family limited partnership and general partner entity.
One of the family limited partnership estate planning strategies that is just kind of ignored by most advisors is the “charging order” protection a family limited partnership offers. Charging orders are used to protect the assets of the limited partnership from the personal creditors and liabilities of the partners (limited or general).
However, all of the family limited partnership estate planning hype is silenced when you realize that a limited liability company does everything a family partnership does. The LLC provides a “corporate shield” plus the charging order protection.
Family limited partnership estate planning is still a popular technique, but you need to look seriously at the LLC. Your advisors had better be able to give some good reasons why you should use a family limited partnership instead of an LLC.
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