THE FAMILY LIMITED PARTNERSHIP: Wealth Preservation
Ever wonder how wealthy families become wealthy? We all know generating wealth requires hard work and a little bit of luck. Passing the fruits of that hard work onto the next generation responsibly can present an array of tax, control and liability challenges. However the solutions are not as complicated as you would think. It is called a Family Limited Partnership. Wealthy families have been using these types of instruments for years to both insulate their estates from liability while minimizing their estate tax exposure.
What is a Family Limited Partnership?
What if I told you there was a way to shield a near infinite amount of money and assets from lawsuits, nasty divorces, creditors, estate tax liability, while maintaining full control over the assets and avoiding the double taxation that ordinarily accompanies Subchapter C Corporations? You would probably say it is too good to be true. And you would almost be right. However for those lucky few high net wealth individuals with the right NY estate lawyer this is a reality. A Family Limited Partnership when set up properly, and that’s a big caveat, can do all of this and more. A Family Limited Partnership is literally a partnership set up for families by estate lawyers to transfer large quantities of wealth from one generation to the next while preserving their assets. With the Revised Uniform Limited Partnership Act, all 50 States provide that assets owned in Family Limited Partnerships are not owned by the individual partners and therefore insulated from judgments. Additionally all assets contained in the Family Limited Partnership pass outside the estate upon death.
How does a Family Limited Partnership work?
A Family Limited Partnership (FLP) as they are called will be set up by your NY estate lawyer. Once created, the grantor will begin placing assets into the FLP. Two classes of stock within the Family Limited Partnership will then be issued. One class will be issued to General Partners and a second class will become Limited Partners. The creators of the Partnership will almost always retain General Partnership stock and will have the sole control over the buying and selling of assets, distribution of assets, and may even dissolve the Family Limited Partnership at any time. Limited Partners are actually treated like beneficiaries of a discretionary trust ordinarily set up for children. This is why they are called Family Limited Partnerships. The intended purpose of the Family Limited Partnership is to help families preserve family owned businesses as they are passed from one generation to the next.
Benefits of the Family Limited Partnership
As we discussed prior, assets within the Family Limited Partnership are insulated from lawsuits and attack because they are no longer deemed to be in possession of the owner. When set up properly assets within the Family Limited Partnership are not usually treated as marital property and may not be subject to attack in divorce proceedings. Additionally, for estate tax purposes, assets within the Family Limited Partnership are not considered testamentary dispositions and pass outside the estates of the Partners. Finally, any assets placed in the Family Limited Partnership are considered illiquid assets for valuation purposes and discounted substantially. Meaning the benefits of the Family Limited Partnership are quite literally unlimited.
For example, lets take a client S who is 50 years old and has 4 children. Client S graduated from City College 28 years ago and has since built a fast food empire. This family fast food business is booming, consisting of 5 franchises netting more than $600,000.00 per year. Additionally, client S owns several houses and commercial retail properties he rents out to tenants valued at nearly$5,000,000.00 generating an additional $350,000.00 a year in rent. At this rate client S and his wife are going to easily exceed the $10.4 million Unified Credit Estate Tax Exemption for married couples, subjecting their estate to 40% Federal Estate Tax liability. Compound the Federal Estate Tax with the minimum 5% New York State Estate Tax liability and client S’s children will have to sell off half the assets in his estate just to pay the estate taxes.
Luckily client S decided to visit his NY estate lawyer to create a Family Limited Partnership. Lets see how a Family Limited Partnership will help spare Client S’s children from losing the family business.
Client S places the $5,000,000.00 in properties into the Family Limited Partnership along with his interest in his 5 franchise locations. He will issue General Partnership stock to both himself and his wife while issuing each of his 4 children shares of Limited Partnership stock. This way, these assets are protected from any potential lawsuits initiated by customers who sue him for food poisoning in his restaurants and slip and fall accidents on his properties.
Additionally, the assets placed in the Family Limited Partnership are discounted 25%, the amount allowable by the I.R.S., as non-liquid assets. Under the current gift tax exclusion a married couple can gift nearly $10.5 million without incurring any gift tax liability. As such, this discounted valuation would allow client S to make a gift to the Family Limited Partnership of nearly $14 million, discounted down to $10.5 million, thus maximizing the amount of wealth that could be transferred free of either estate or gift tax liability. Additionally a married couple can gift an additional $28,000 to each child each year without being charged against their gift tax exclusion. If these benefits were not enough it gets even better for client S and his heirs. Supposing at the time of client S’s death 30 years from now, the assets’ value has grown annually at a compounded rate of 10%. After annual distributions there would still be nearly $60,000,000.00 in this Family Limited Partnership far exceeding any Unified Estate Tax Credit in existence at that time. However, since the assets within the FLP are not considered testamentary dispositions, they will not be calculated as estate assets and will not generate any estate tax liability. The Family Limited Partnership just saved Client S’s heirs more than $30,000,000.00 in estate tax liability.
Pitfalls of the Family Limited Partnership
As previously noted, the Family Limited Partnership can seem too good to be true and often is. Like most estate strategies this one does everything and more when set up and implemented properly by experienced NY trust & estate lawyers who know what they’re doing. However the Family Limited Partnership can be an unforgiving nightmare when set up improperly. Like all formidable endeavors the devil is in the details and the FLP is no different. First, the FLP requires an actual family partnership. In the landmark case Matter of Strangi , Mr. Strangi decided to form a Family Limited Partnership without any other general partners for the sole purpose of removing $10 million of assets, mostly cash and equities, from his estate to avoid the inheritance tax. The Court found that this use was not a valid business purpose within the statutory purpose of the FLP as intended by the legislature. The Family Limited Partnership is designed to preserve business assets so they may be transferred from one generation to the next within families and not mere tax avoidance. InStrangi the Family Limited Partnership was struck down and the assets were deemed part of the decedent’s estate and subject to substantial estate tax liability.
The Family Limited Partnership is a serious estate strategy, not intended for the novice planner and the faint of heart. As you see above if the FLP is not set up properly for the appropriate purposes the results can be catastrophic. The FLP requires strict adherence to filings in accordance with Section 2701 of the tax law and requires that monetary distributions from income generated from the FLP assets be issued annually to each shareholder in a professional manner. Additionally the FLP cannot be done at the last minute while the decedent is on their deathbed, as this will be viewed as nothing more than a last ditch effort at tax avoidance.
Should you or someone you care about require NY estate tax guidance, please feel free to contact one of our New York wealth preservation attorneys at the Law Offices of Jason W. Stern & Associates at (718) 261-2444.
If you would like to know more about this topic feel free to follow our firm on Twitter @NYEstate_Law.
