Could My Family Benefit from a Family Limited Partnership?

Effective estate planning should address wealth transfer from a practical and cost-effective approach. One estate planning strategy that families with closely held businesses should consider is the family limited partnership.
 

WHAT IS A FAMILY LIMITED PARTNERSHIP?
A family limited partnership is a partnership agreement that exists between family members who are actively involved in a trade or business. The partnership divides rights to income, appreciation and control among the family members, according to the family’s overall objectives. Under family partnership rules, the “family business” can include real estate or investments.
 

HOW IS THIS ARRANGEMENT ACHIEVED?
Under the most common form of family partnership, a business owner would begin by creating general and limited partnership interests in his or her business. Once the partnership is established, the owner then gifts the limited partnership interests to his or her children.

By holding the general partnership interest, the parent is considered the “general partner” and maintains control over the enterprise. The children are the “limited partners,” and the limited partnership interest lets them share in the ownership of the business.
 

A SOUND STRATEGY FOR TRANSFERRING OWNERSHIP
A family limited partnership enables a business owner to provide his or her children with an interest in the business while achieving many goals. First, the parent can gauge whether or not the children possess suitable ownership abilities by involving them in the business. Second, it removes the asset from the parent’s estate, thus lowering the estate tax liability, if properly executed. In addition, the parent can transfer the limited partnership interests in increments over time, resulting in a gradual, systematic transfer of ownership. Finally, and perhaps most importantly, there may be immediate income tax benefits.
 

ESTATE TAX SAVINGS
The interests transferred to the owner’s children, including all appreciation since the transfer, escape inclusion in the parent’s estate at time of death. Only the value of the taxable gift(s) will be included. This can result in estate tax savings down the road.
 

THE BENEFITS OF LEVERAGE
By giving the partnership interests in increments over time, the parent can take maximum advantage of the $13,000 annual gift tax exclusion. The exclusion increases to $26,000 if you’re married and if each spouse elects to give the maximum amount. The gift tax exclusion is indexed for inflation.

In addition, “minority discounts”—allowable reductions to the value of the gift because it is a minority interest—can lead to greater leverage of the annual exclusion and the unified credit. For instance, the parent may be able to discount the value of the gift up to 30 percent or more. However, in order for the discount to be valid, there must be a legitimate business reason for the partnership.

Generally, the business owner’s wish to keep the business in the family is a legitimate reason to set up a partnership agreement—as long as you are joined together for the purpose of enterprise and not just to avoid taxes.
 

INCOME TAX BENEFITS
Aside from the estate planning advantages, the family limited partnership can result in substantial income tax savings. By including the owner’s children as partners and sharing partnership income with them, total family taxes may be reduced.

Business owners should be aware, however, that if the income is unearned and the recipient is under age 14, “kiddie tax” rules will apply.
 

OTHER OPPORTUNITIES CAN SERVE YOUR FAMILY
In addition to family limited partnerships, there are other arrangements that can serve family interests:

• Family partnerships are arrangements under which each partner must play a role in the management and day-to-day operations of the business. Many of the benefits are similar to that of a limited partnership, but the family members accept more liability and will be more involved in the business. As managing partner, however, you must always receive a minimum income share that is proportional to the value of your services. In addition, minors typically cannot be partners unless there is someone who controls the interest for the minor.
   
• Investment partnerships are partnerships that hold non-business assets, such as securities and real estate, that are likely to grow in value. Families can base a limited partnership on an investment partnership. In some cases, however, the arrangement would be considered an investment company, and gains and losses will be realized on the transfer of property to the partnership. Normally, under partnership rules, gains and losses are not realized when transferred to the partnership.

SEEK PROFESSIONAL GUIDANCE
The benefits of the family limited partnership can be significant. But they can only be realized if the arrangement is valid under the requirements of the Internal Revenue Service. Consult a qualified legal or tax advisor if you think your family could benefit from a family limited partnership.

This article was written by Wells Fargo Advisors and provided courtesy of Kristopher Venne in Syracuse, N.Y. Venne can be contacted at 800-448-5773 or through www.bombardcavanaugh.com.

Investments in securities and insurance products are not FDIC-insured, not bank-guaranteed and may lose value. Wells Fargo Advisors LLC, member SIPC, is a registered broker-dealer and a separate non-bank affiliate of Wells Fargo & Co. Wells Fargo Advisors does not render legal or tax advice. The information in this article is not intended to be tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor.