How does an FLP Work?
An FLP is formed when two or more members enter into a partnership agreement, which outlines the rights, responsibilities, and rules of the partnership. The agreement will detail the structure of the partnership interests—including who is the general partner, limited partners, manager, and beneficiary—as well as the FLP’s purpose and duration.
Partners must also decide on the FLP’s assets—including land, businesses, investments, real estate, or other assets—and the contribution each partner makes. Generally, the general partner has control over the FLP while the limited partners have limited liability and relinquish control of the FLP’s decisions and assets to the general partner.
Benefits of an FLP
There are several benefits to setting up an FLP:
- Asset Protection: FLPs provide asset protection from creditors, taxes, and other legal liabilities.
- Tax Benefits: FLPs provide tax benefits to the partners, such as deferring and/or reducing taxes on capital gains or income.
- Estate Planning: FLPs enable the transfer of assets to the next generation in a tax-friendly way.
- Ease of Administration: FLPs are generally easily administered, and their formalities are relatively minimal.
Risks of an FLP
It is important to note that while an FLP can provide substantial asset protection and tax savings, it can also carry significant risks. Potential pitfalls include:
- Lack of Control: Limited partners relinquish control of the FLP’s decisions and assets to the general partner.
- Potential Tax Liabilities: The IRS may challenge the FLP’s structure and assess taxes that would not otherwise be due.
- Family Conflict: The partnership agreement should be discussed, agreed upon, and signed by all partners, which can lead to family conflict if not done amicably.
- Complexity: FLPs can be complicated to set up and require knowledgeable professionals to assist in their formation.
Family limited partnerships are an effective way to manage, protect, and transfer family assets. They provide tax and asset protection benefits and enable asset transfers to future generations. However, they also involve complex rules and may expose partners to potential tax liabilities and family conflict. Before establishing an FLP, it is critical to discuss the structure with knowledgeable professionals and family members to ensure the FLP accomplishes its objectives while mitigating the associated risks.