This is the second part of a two-part series. Click here to read the first part.

HE SAYS:

As was stated in our last post, a Family Limited Partnership (FLP) can, under the right circumstances, be a very effective estate planning strategy for the transfer of a family business to the next generation; however, it is not something anyone should pursue without careful consideration.

One of the most important steps in forming a FLP is determining the value of the business.  The fact that most small businesses are not very liquid allows the valuation, for purposes of the FLP, to be discounted by as much as 35% to 45%.  The premise is that the value of only a part of the business can be reduced based on the fact that very few people would buy a partial interest in a privately owned family business which does not have a ready market for resale.  This creates the advantage of allowing the business owner to transfer, through the use of the annual gift tax exclusion, interests in the business to his/her children at a faster rate due to the discounted value.

Perhaps, the biggest advantage of a FLP is the applicable tax rate.   Because the income of the FLP is not taxed at the partnership level but is passed through to the individual partners’ personal tax returns, the applicable Federal tax rates for the FLP are based on the individuals’ Federal income tax rates rather than the higher rates generally applicable to trusts.

It must be pointed out that the IRS, in an effort to prevent abuses, has issued regulations that affect FLPs.   In order to qualify for the pass through taxation rules, the FLP must meet the following requirements:

  • the partnership must be bona fide and each transaction must be entered into for a substantial business purpose;
  • the form of each transaction must be respected under substance over form principles; and
  • the tax consequences of each partner must accurately reflect the partner’s economic agreement and clearly reflect the partner’s income.

Since this is a very complicated area of the law, it is highly recommended that you consult with a knowledgeable Accountant, Certified Financial Planner and/or Attorney who specializes in estate planning before you take any action.

WHAT DO YOU SAY?