What Is a Family Limited Partnership?

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We all want to avoid taxes, and not just the kind imposed on our weekly or monthly income. The fact of the matter is that any time you receive money, even if it's in the form of an inheritance, the IRS tries to get a piece of it. If your family has amassed a substantial amount of wealth, it might pay to look into a family limited partnership.

As the name implies, a family limited partnership, or FLP, is a limited liability partnership controlled by members of a given family. FLPs feature two types of partners: general and limited. General partners control all aspects of managing the FLP, which works like a business of sorts, while limited partners are there as investors only. When used correctly, an FLP can be a smart estate-planning tool, so if you're looking to protect your family's assets, it pays to explore this option.

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Benefits of family limited partnerships

To establish an FLP, a formal partnership agreement is drafted, typically by an estate-planning lawyer. Once that's completed, family assets may be transferred into the partnership. These might include cash, real estate, or securities.

The primary advantage of an FLP is that it could, under the right circumstances, help you avoid estate and gift taxes when passing assets on to children or grandchildren. Under an FLP, your family's resources are pooled into a single business partnership, whose shares can be distributed to future generations at a lower tax rate than what you'd pay in estate or gift taxes. FLPs are also fairly flexible and can typically be amended as family circumstances change, such as in the case of divorce.

FLPs can also save families money by minimizing investment and legal fees. Say your family has 12 distinct members, each of whom would normally have his or her own brokerage account and trust. That's a lot of investment fees to be paying on transactions and a lot of money to potentially be forking over in legal costs. By combining finances and legal protections into a single partnership, you can not only consolidate your family's assets, but avoid the fees associated with managing, growing, and protecting them.

The downside of FLPs? First, they can be costly to set up, though that's true of legal trusts, as well, which are common among the wealthy. Furthermore, general partners in an FLP aren't protected from potential lawsuits or judgments the same way limited partners are. Finally, though FLPs can be an effective tax mitigation tool, they also tend to be subject to IRS scrutiny. Remember, an FLP is supposed to serve an actual business purpose, so if you set one up, you'll need to conform to that expectation.

Is a family limited partnership right for you?

The answer? Maybe. It depends on your family's circumstances, including the level of wealth at play and your plans for distributing it over time. In some cases, you might be better off with a trust fund instead.

Also, keep in mind that under the new tax changes, fewer families will be on the hook for estate taxes going forward. That's because individuals now get an $11.2 million lifetime exemption, and this figure rises to $22.4 million for married people. In other words, unless you're extraordinarily wealthy, the estate tax may not apply to you in the first place, thus negating much of the benefit of an FLP.

That said, if you are among the ultra-rich, consult an attorney and see if an FLP is right for you. It's probably worth a phone call at the very least.

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