Navigating the Sunset: How Family Limited Partnerships Can Preserve Your Family's Wealth

Estate planning and wealth transfer strategies for affluent families is getting more complicated, considering both increased IRS enforcement, as well as significant estate law changes scheduled to take effect at the end of 2025.

Currently, the federal estate and annual/lifetime gift tax exclusion is $13.61M per person. This means you can transfer up to this amount of assets to heirs, either during your lifetime or at death, without paying any federal gift or estate tax. Any assets passed above this exemption amount would be subject to a 40% transfer tax (!). This is an historically high exemption amount and is scheduled to expire, or “sunset,” on December 31, 2025 – and, therefore, more estates will be subject to federal estate tax, increasing the tax burden on larger estates.

The looming sunset creates an urgency for high-net-worth individuals and families to engage in estate planning strategies now to take advantage of the higher exemption amounts.

Enter the Family Limited Partnership (FLP). This can be a viable estate planning tool for families, but it's important to understand their advantages and disadvantages before deciding if one is right for you.

FLPs can help families:

1. Transfer wealth - FLPs can help families pass assets and/or business interests to their heirs, which can increase the family's generational wealth.
2. Minimize estate tax liability - FLPs can reduce the value of assets due to a lack of control and marketability, which can lower the total estate value and taxes owed. Future returns are also excluded from the estate.
3. Protect assets - FLPs can protect assets from creditors and help ensure a smooth succession of a family business when the owner dies.

Let’s take a look at the specifics, including types of assets that can be transferred into an FLP, the overall structure, as well as the estate planning benefits.

Types of Assets Suitable for an FLP

An FLP can be used to manage and transfer various types of assets, beyond just a family-owned business.

Here are some other examples of assets that can be included in an FLP:

• Real Estate: Residential, commercial, or rental properties can be placed in an FLP. This allows for centralized management and potential tax benefits.
• Investments: Stocks, bonds, mutual funds, and other investment accounts can be transferred into an FLP to facilitate wealth transfer and estate planning.
• Cash and Liquid Assets: Bank accounts and other liquid assets can also be included, providing flexibility for the partnership to manage funds.
• Collectibles: Valuable collections, such as art, antiques, or jewelry, can be managed and preserved within an FLP.
• Other Assets: Any other valuable assets, such as intellectual property or royalties, can be included.

Structure

A Family Limited Partnership does not issue shares in the same way that corporations do. Instead, ownership in an FLP is represented by partnership interests.

An FLP consists of at least one general partner (GP) and one or more limited partners (LPs), all with partnership interests. The general partner – typically the senior family member – manages the partnership and has unlimited liability, while limited partners – typically the children or other family members – have limited liability and do not participate in management. Essentially, the GP manages the FLP’s assets, making decisions about investments, distributions and other operational matters. This ensures that the senior family member(s) can maintain control over the assets. (There is a benefit to this “lack of control” for the LPs, and is something that we will further discuss in a minute…)

Meanwhile, the FLP generates income from its assets, which can be distributed to partners according to the partnership agreement. This income can be split among family members, potentially reducing the overall tax burden.

Estate Planning Benefits

This is where the major benefit of this estate planning structure kicks in.

Parents can gift interests to their children, utilizing the annual gift tax exclusion ($18,000 per recipient in 2024) and the lifetime gift tax exemption ($13.61M per individual in 2024) mentioned above. By gifting limited partnership interests to children, the parents can potentially reduce their taxable estate.

By transferring FLP interests over time, the overall value of the parents' estate is reduced, potentially minimizing estate taxes upon their death.

An additional benefit is what’s called the “valuation discount.” ?This discount acknowledges that limited partnership interests are less attractive to potential buyers due to certain restrictions and lack of control.

When transferring FLP interests to the LPs, valuation discounts for this lack of control and marketability can reduce the value of the gifted interests, thus lowering gift and estate tax liabilities even more. Think of it as giving your kids a discount on their inheritance while the IRS foots part of the bill.

Consider a family with an FLP holding assets valued at $10 million. The parents want to gift limited partnership interests to their children. Without any discounts, a 10% limited partnership interest would be worth $1 million.

However, due to the lack of control and marketability, a combined valuation discount of 30% (15% for lack of control and 15% for lack of marketability) might be applied. Here’s how it works:

• Unadjusted Value: 10% of $10 million = $1 million
• Valuation Discount: 30% of $1 million = $300,000
• Discounted Value: $1 million - $300,000 = $700,000

Thus, for gift tax purposes, the 10% limited partnership interest is valued at $700,000 instead of $1 million. This discount reduces the taxable value of the gift, which can lead to significant tax savings.

Meanwhile, assets within an FLP are generally protected from creditors' claims against the LPs, adding a layer of security for the family’s wealth.

And as the general partner, as previously mentioned, you can retain control over the business or assets even after transferring ownership interests to your children as limited partners. It's like handing over the keys to the kingdom while still holding onto the crown.

For Example….

Suppose you own a family business. You can establish an FLP, transferring the business into the partnership. You, as the general partner, retain 1% interest and control. You then gift limited partnership interests to your children, taking advantage of valuation discounts. Over several years, you transfer additional interests, leveraging annual gift tax exclusions and potentially reducing your taxable estate while maintaining control of the business.

Now, let’s suppose that this business is valued at $20 million. Under the current estate tax exemption of $13.61M per individual, the business owner could establish an FLP and transfer the business into the partnership and then gift FLP interests to children, leveraging the exemption, potentially with significant valuation discounts.

This is an historically high exemption amount and is scheduled to expire, or “sunset,” on December 31, 2025, unless Congress acts to extend it or make it permanent. If no action is taken, the exemption amount will revert to its pre-TCJA (Tax Cuts and Jobs Act of 2017) level of $5.6 million per individual, adjusted for inflation from 2017.

So potentially, after 2025, the reduced exemption could result in a substantial estate tax liability, making it advantageous to transfer assets before the sunset.

By carefully planning and executing the FLP strategy, you can effectively pass along your business or assets to your children, reduce estate and gift taxes, and ensure continuity and control over family assets. And remember, it’s like setting up a family trust fund but with some added control.

Additionally, with the estate tax exemption set to sunset, a Family Limited Partnership can be a valuable tool to optimize estate planning and minimize tax liabilities, making it a strategy worth considering during this period of changing tax laws.

#FLP #familylimitedpartnership #retirementplanning #financialplanning #feeonlyadvisor #CFP

Bill Davis is a CERTIFIED FINANCIAL PLANNER? and Managing Partner with Vericrest Private Wealth LLC, a financial advisory firm in Newtown, Pennsylvania. We provide fee-only, objective advice to our clients.

Vericrest Private Wealth LLC ("Vericrest") is an SEC registered investment advisory firm.??The information provided herein should not be?construed as personalized investment advice and should not be considered as a solicitation to buy or sell any security or investment advisory service.?Past performance is no guarantee of future results, and there is no guarantee that future investments will be profitable.? ?While we believe that third party information provided is accurate, Vericrest does not guarantee or otherwise warrant such information. ?For more information please contact Vericrest or refer to the Investment Adviser Public Disclosure website?(www.adviserinfo.sec.gov) to review important disclosures about our firm.