FLPs are typically holding companies, acting as an entity that holds the property (business interests, real estate investments, publicly traded or privately held securities) contributed by the members. FLPs have several benefits. They allow family members with aligned interests to pool resources, thus lowering legal, accounting, and investing costs.
They allow one family member, typically the GP, to move assets to other family members (often children who are LPs), while still retaining control over the assets. Because the LPs have no rights of control, they cannot liquidate their partnership interest.
FLPs also allow for favorable tax treatment relating to the transfer of the assets, relating to the lack of control, and lack of marketability of LP interests discussed above. Taxes are paid on the fair market value of assets bought or given. Fair Market Value is the value that would be received (paid) to sell (buy) an asset between a hypothetical willing buyer and hypothetical willing seller, both acting in their own best interest and with reasonable knowledge of the relevant facts when neither is acting under compulsion.
An FLP also protects assets from claims of future creditors and spouses of failed marriages. Creditors may not force cash distributions, vote, or own the interest of a limited partner without the consent of the general partners. And in the event of a divorce, where a limited partner ceases to be a family member, the partnership documents can require a transfer back to the family for fair market value, keeping the asset within the family structure.
An FLP can also be formed as a family limited liability company (FLLC), which offers legal advantages over an LP. While the GP of an FLP is personally liable for all debts and obligations of the FLP no “member” (instead of “partner”) of a FLLC is personally liable. Furthermore, in an FLLC, there are no restrictions on members participating in management, unlike the restrictions on LPs. A FLLC is often managed by a group of “managing members” or one or more “managers”.
Because an FLP or FLLC is a real business entity, it should be treated as one. Meetings should be held on a regular basis to review the conduct of the entity’s investment business. The entity must make any distributions proportionately to all partners or members. It should never be used as the personal bank account of the founder.
It is important to note that while FLPs are completely legal, deliberately engaging in any practice the IRS deems to be specifically undertaken to evade paying taxes is illegal. Determination of the fair market value must be performed by a qualified appraiser, typically defined as someone certified to perform such work.
This article is for informational purposes only and neither LPL Financial nor any of its representatives provide tax, legal or accounting advice not a complete summary of information needed to recommend any investment. Consult the appropriate professional to determine how this information applies to your unique situation.
About the Author: Charles Marsala is LPL Financial Advisor with Benchmark Investment Group with Securities offered through LPL Financial, a member FINRA/SIPC. He can be contacted at Charles.Marsala@lpl.com