"Keeping It In The Family" With Family Limited Partnerships

One of the biggest goals of the affluent is to reduce estate taxes as much as possible when passing family assets to the next generation. As of 2007, the Internal Revenue Service (IRS) allows every individual to pass two million dollars as an inheritance to be divided by their children or other beneficiaries, totally estate tax-free. This means a married couple can leave up to four million dollars tax-free. There is a creative tax-shelter that can help maximize these limits called Family Limited Partnerships, also referred to as FLiP’s.

You can compare a FLiP to a traditional Limited Partnership used by businesses with two or more partners. In the case of the FLiP, however, all of the partners must be family members. All limited partnerships have general partners and limited partners. General partners (in the case of the FLiP we’ll call them “the Parents”) run 100% of the business, even if they only have a 1% ownership in it, while limited partners (we’ll call them “the Children”) have no voice or voting rights.

When the FLiP is created, the Parents are the general partners and the limited partners. They put their assets into the limited partnership and then gift up to 99% of the shares of the partnership to their children, who become the limited partners. The Parents will remain the general partners and retain control over all the assets until their death, at which time the Children become the general partners.

One benefit of doing a FLiP is saving taxes. When the assets are transferred to the partnership, there is an immediate and substantial discount in the value of the assets for estate tax purposes. This discount is allowed by the IRS because, even though the Children own the assets, they have no control over them. In other words, instead of leaving your children four million dollars when you die, you can put four million dollars into the FLiP, which, because of the discount, would be viewed in the eyes of the IRS as a much smaller gift. Therefore, you can add more assets to the FLiP until the discounted amount equals four million dollars. The actual amount of the discount may be different for each estate due to various factors involved in the valuation. For example, cash in the partnership receives less of a discount than securities or real estate.

Another benefit of the FLiP is appreciation of the partnership assets is not included in the Parents estate. If the Parents live another 20 years, these assets could be worth double or triple the value they were at the time of transfer, saving hundreds of thousands of dollars in estate taxes to the Children. Since there is no limit to the amount of assets that can be transferred to a FLiP, very affluent families could save their children millions in estate taxes. nn