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Family Limited Partnerships - The Basics

Many people are wondering what exactly an FLP is, and why has it become so popular?

The term "Family Limited Partnership" (FLP) has no technical reference or definition in the Internal Revenue Code. This is because an FLP is just a limited partnership whose limited partners are family members. The FLP's popularity is a result of the donor's ability to transfer assets down to his descendents at a lower transfer tax cost than would be otherwise be incurred with a direct transfer of the assets to descendants. Coupled with the donor's ability to retain control of the assets by retaining control of the general partner, the limited partnership is a very attractive estate planning tool.

The parents own the various assets. Although they can serve as general partners in their individual capacities for creditor protection purposes, they establish and capitalize an entity to act as general partner of the FLP. This entity is usually an S Corporation or an LLC because these entities are taxed as "pass through" entities. The entity and the parents (and the children too, if they desire) in the beginning form the limited partnership with the general partner holding a 1% interest and the parents owning the remaining 99% interest in the partnership. In exchange for its interest in the partnership, the general partner contributes 1% of the capital and the parents then contribute the remaining assets to the partnership. The parents then assign their limited partnership interests to their children either immediately or over time, depending upon which would produce the lowest overall transfer tax cost. If any of the donees are minors or are in need of spendthrift protection from creditors, trusts may be used to hold their interests in the partnership. This structure allows the parents, as general partners, to transfer interests in the limited partnership to the children as well as control the management and investment decisions of the partnership.

Family Limited Partnership Term

The FLP is normally structured as a fixed term partnership. A limited partner generally has a right to withdraw from the partnership, and to receive the fair value of the limited partner's interest, by giving six months notice. However, that provision does not apply if the agreement specifies "the time or the events upon the happening of which a limited partner may withdraw or a definite time for the dissolution and winding up of the limited partnership." For instance, the limited partnership may provide that it is to last for thirty years. In that case, under appropriate state law principles, limited partners would not have the right to withdraw prior to the end of the thirty year fixed term.

Management

General Partners have all management rights with respect to the limited partnership. Limited partners are excluded from the management of the partnership except in respect to certain limited matters designated in the Revised Uniform Limited Partnership Act (RULPA). If a limited partner takes part in the control of the partnership, he may lose his limited liability status with respect to a person who transacts business with the partnership reasonably believing that the limited partner was a general partner.

Allocation of Income and Gain

Income and gain is allocated among the various partners in accordance with their percentage interests in the partnership. The Internal Revenue Code contains detailed rules that must be satisfied in order for allocations of income and gain to be respected. There are special rules under Section 704(e) of the Internal Revenue Code applying to family partnerships (although it is typically easy to structure the partnership in order to satisfy the special family partnership requirements.)