How An FLP Is Formed How It Operates Its Potential Advantages Or Disadvantages

Barry Zimmer Estate Planning Attorney The Zimmer Law Firm 513-721-1513

Preserving a family business takes a good deal of careful financial and estate planning, with the goal of keeping the business intact and financially healthy.
Despite the rise of conglomerates and mega-stores throughout the United States, family businesses are still alive and well in America. For most people, a family business is more than just a way to earn a living it is a legacy that needs to be protected and preserved for future generations. Preserving a family business takes a good deal of careful financial and estate planning, with the goal of keeping the business intact and financially healthy. It is therefore important to choose the right kind of entity for your family business to form. The choices of entities can seem overwhelming, and its wise to carefully analyze and consider the future impacts your choices will have on your business. Many family businesses form a family limited partnership, or FLP. Read on to learn how an FLP is formed, how it operates, and to learn about its potential advantages or disadvantages.

Family-owned businesses, farms, ranches, and land holdings are often the most important and valuable asset of a familys legacy. Sadly, less than 30% of family businesses survive the transition to the next generation a problem that is sometimes but not always caused by estate taxes. More often businesses fail after the founders die due to issues not related to taxes.

What Is a Family Limited Partnership?

When family members create an FLP, they join in a legal partnership, becoming joint owners of family-owned assets, such as those connected with a family-owned business. There are two classes of partners: general and limited. In an FLP, general partners are legally liable for the actions of the partnership. Limited partners, meanwhile, are not legally accountable for group actions, and their liability is limited to the value of their partnership interest. General partners have complete control over the partnerships operations, and share in profits and distributions. Limited

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partners still share profits and distributions from the FLP, but do not have control over operations.

In an FLP, general partners are legally liable for the actions of the partnership. Limited partners, meanwhile, are not legally accountable for group actions, and their liability is limited to the value of their partnership interest.

How Is a Family Limited Partnership Formed?

The first step in creating an FLP is to file paperwork with the Secretary of State of the FLPs home state. The name of the filing may vary among states, but will be something like Articles of Limited Partnership or Certificate of Limited Partnership. The form and filing instructions will most likely be available online. When filing the initial form with the Secretary of State, you will need to appoint a Statutory Agent. If your FLP is ever sued, the Statutory Agent will receive initial lawsuit filings on behalf of the partnership. If you form your FLP in a state where you dont live, there are companies who provide this service. The next step is to execute a written partnership agreement. Among other details, the agreement will name the general and limited partners, and will assign them duties and responsibilities. There will also be provisions addressing how partnership interests can be sold, transferred, or encumbered, all of which are necessary for keeping the FLPs assets in the family. Therefore, unlike other partnership agreements, an FLP agreement will usually forbid selling, transferring, or otherwise encumbering a partners interests to anyone outside the family.

Creating a family limited partnership can help you meet such diverse goals as estate planning and lawsuit protection.

What Are the Advantages of a Family Limited Partnership?

There are a number of advantages to forming an FLP, some of which concern tax, transfer, and liability issues.

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Liability and Control

Bringing future generations into a family business can present some difficulties. The next generation will have a lot to learn, and they may not be ready to jump in and make decisions right away. They may also have doubts about taking on the responsibilities and risks of running the business. An FLP allows you to slowly and incrementally bring a child or grandchild into the business, limiting the individuals control over business decisions and protecting him or her from liability if something goes wrong.

Transfer of Ownership
When a group forms an FLP, they also create fractionalized interests in the partnership. Think of these interests as the equivalents of stock in a publicly traded corporation. For example, imagine that Bob and Mary Johnson own a family landscaping business. The business has done well over the years and owns approximately $12 million in assets. Among those assets are about 100 acres of land for growing trees, shrubs and flowers; a warehouse for storing materials and equipment; an office building; a small fleet of trucks and other vehicles; and various other assets used in the daily running of the business. The Johnsons also oversee some of the businesss financial accounts. When Bob and Mary create their FLP, all of these assets go into one pot. The general and limited partners own shares or interests in the partnership. When the couple wishes to begin transitioning their business to the next generation, they will only gift pieces or shares of the

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Specially designed Family Limited Partnerships, with a gifting plan, can reduce estate taxation and still allow the business founder to maintain operating control.
FLP, instead of gifting interest in the businesss underlying assets. As the heads of their business, Bob and Mary will maintain control over the companys operations - and ownership of the general partner interests until retirement or death. The Johnsons might also choose to give yearly gifts of interests to their children and/or grandchildren without affecting their control over the company.

Partners in an FLP do not directly own interest in the business assets; they own the FLP. Limited partners in an FLP have less control over the business than general partners, and they also have less control over the interest theyve received through the partnership.

Tax Savings
This is where the FLP gets interesting. Both lifetime gifts and gifts passed down at the time of death are subject to taxation. However, taxpayers may still gift or bequeath assets up to the current lifetime exclusion amount, set at $5.25 million for 2013, and indexed for inflation. Annual gifts of $14,000 per donor per donee (in 2013; indexed for inflation for future years) can be made in addition to the lifetime exemption of $5.25 million. Put simply, the value of the gifted asset or property determines whether the gift is taxable or tax-sheltered. As discussed above, partners in an FLP do not directly own interest in the business assets; they own the FLP. Limited partners in an FLP have less control over the business than general partners, and they also have less control over the interest theyve received through the partnership. Therefore, a limited partners interests are not as valuable as those of a general partner. Due to this difference in value, limited partner interests receive a discount, since somebody buying those interests would pay less than the partnership interests pro rata

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value, due to lack of control over partnership operations and other factors. Referring back to the example of Bob and Mary Johnson, suppose that the landscaping business FLP owns $10 million worth of assets. Their daughter, Sally, owns a 10% limited partner interest. Since Sally is a limited partner, her share is actually worth less than 10% of the partnerships $10 million, and this difference would still be relevant if Sally wanted to sell her interest and cause the price to be less. This is the basis for a valuation adjustment or discount when reporting the gift on a gift tax return or valuing the assets on an estate tax return. Of course there are details to be seen to, such as appraisals to support the discounts.

Protecting Your Assets With The Family Limited Partnership

Are you worried about being sued? Well, you should be. It is reported that there are 18 million lawsuits in the United States each year. However, that isn't the whole story. Have you ever heard of the "deep pocket" syndrome? The deep pocket syndrome means that the person claiming to have been harmed files a suit against anyone even marginally connected with the incident. Click to Get Your Complimentary Edition of the Report Protecting Your Assets With The Family Limited Partnership

Lawsuit Protection
An FLP can also provide valuable lawsuit protection. If a partnership gets in legal trouble and is sued, the limited partners are only at risk for what they have put into the partnership in exchange for their partnership interests. Limited partners personal assets are not at risk. Similarly, if a limited partner gets sued for reasons not related to the partnership, the judgment creditor cannot take over the partners interest and force it to be sold to pay the claim. At most, the creditor will get a charging order, which would allow the creditor to receive FLP payments originally intended for the limited partner. Since the general partner controls the distributions to the limited partners, this puts the limited partner / debtor in a better position to negotiate a favorable settlement, or perhaps dissuade the judgment creditor from even trying to collect. The general partner, on the other hand, has unlimited liability. That means if the partnership is sued, the judgment creditor can collect against the general partners personal assets and income to satisfy the FLP liabilities. This can be a serious risk.

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But this risk is managed by making the general partner an entity that protects the individual owner from liability. The Limited Liability Company is often an ideal tool for this purpose.

What Are the Disadvantages of a Family Limited Partnership?

An FLP can be costly to set up initially, but the tax savings generally far outweigh the cost of creation. There has also been some speculation about the future of discounts in FLPs. The American Taxpayer Relief Act of 2012 did not include any significant changes to FLPs, so for now it appears as though they are still an excellent option for anyone who wishes to preserve and pass down a family business to future generations. But it is anticipated that future tax legislation proposals could include measures that restrict this very powerful tax planning tool, so acting sooner rather than later would make your new FLPs grandfathered under currently existing law, rather than covered by the new law, as a general rule.

Barry Zimmer engages in a Wealth Care Practice. Specific services include basic and advanced trust planning; trust estate settlement; probate estates; trust beneficiary advocacy and representation; asset protection; business organization; business succession planning; and pre-marital planning. His goal is to make creating a Wealth Care and Estate Plan the first step in a relationship that is satisfying and unlike a client's experience with any other lawyer.

The Zimmer Law Firm 9825 Kenwood Road, Suite 201 Cincinnati, OH 45242 Phone: (513) 721-1513 info@zimmerlawfirm.com

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