A family limited partnership (FLP) is a limited partnership in which all or most partners are family members. A family limited partnership is a legal business structure used by families, so they may combine their resources to do business or invest.
Each family member who participates in an FLP receives ownership shares in the partnership in exchange for their investment. In effect, they become a shareholder, and each has the specific powers and authority given to them by the partnership or operating agreement for the FLP.
Most FLP agreements provide that shares cannot be sold until a specific period has passed. Also, if a partner sells their share units, they are subject to regulation by the Securities and Exchange Commission (SEC). Partners who want to sell their shares in an FLP should understand that these transactions must meet requirements set under the Securities Act of 1933.
FLPs sometimes function as holding companies, where family members pool resources and assets to accomplish a collaborative business goal. The FLP structure may qualify the business or its shareholders for certain tax breaks and other financial benefits.
How Do Family Limited Partnerships Work?
In an FLP, one family member is usually chosen to serve as the general partner (GP). The other partners are limited partners (LPs). The general partner is generally the managing partner, i.e., the one responsible for controlling and directing the partnership activities. They may also manage various transactions and contracts involved in the FLP’s business operations.
The limited partners have certain rights but are very limited in managing the FLP’s business operations. They cannot be involved in executive decisions because if they are, they risk losing the protection of their limited partner status.
General partners may be paid if the partnership agreement provides for that. Sometimes general partners are compensated with a percentage of the FLP’s profits, while others get a fixed annual salary. They also have unlimited liability. If any of the projects fail, creditors can pursue the general partner’s personal assets to cover business debts and liabilities.
Limited partners vote on the partnership agreement, establishing the family-limited partnership rules. They also collect dividends, interest, and profits the business generates according to their shareholdings.
As a general rule, limited partners cannot lose more than they have invested in the partnership unless they begin taking on general partner responsibilities. One common benefit of the FLP structure is that transfers can often be made between family members without paying a gift or other taxes.
What Are Some Examples of a Family Limited Partnership?
Reportedly, Sam Walton, the founder of Walmart fame, used the FLP structure when he created Walton Enterprises, LLC. His goal was to allow his children and other family members to own shares of Walmart Stores, Inc., and other investments. Of course, the plan paid off unbelievably well for the family members.
What Advantages Does a Family Limited Partnership Have?
Advantages of FLPs include:
- Tax Savings in Estate Planning: The growth in value of the business that an owner realizes can be transferred to other family members free of taxation. This reduces the size of the owner’s estate’s size and their inheritance tax liability. Often, FLP owners hope to transfer their ownership interest in an FLP to their children. They can manage this by making gifts with an annual gift tax exclusion.
- The amount that can be given as a gift every year without incurring gift tax liability is $15,000 per person. Therefore, setting up and running an FLP is a strategy for business owners to slowly shift the tax burden to their children and avoid the payment of inheritance tax on the transfer;
- Protection of assets: In an FLP, the family can maintain control of the business’s assets because the assets are considered the partnership’s property. Outside investors would not be able to intrude and gain control of family business assets.
- If a limited partner should leave the family, e.g., through a divorce, they must return the shares to the business. Again, this maintains complete ownership and control of the business within the family;
- Family Wealth Transfer to Future Generations: An FLP is a way for families to preserve the family business for descendants and heirs and transfer assets to them. Usually, the senior members of a family, i.e., parents, are general partners in an FLP. Parents can eventually transfer their shares in the FLP to their children if their children are limited partners. This enables their children to become general partners and fully manage the business in the future.
What Disadvantages Does Family Limited Partnership Have?
Disadvantages may include:
- Best Structure for the Business: Not all businesses suit the FLP structure. Family limited partnerships are considered best for businesses involving real estate or companies with significant tangible assets. For businesses with intangible assets and focused more on services or investing, such as training or consulting, the FLP structure may not be the best choice;
- Unlimited Liability of General Partners: The general partners are personally liable for all the business debts. The general partners must hand over personal assets to cover the business’ financial obligations. General partners are also liable for the actions of other general partners.
- On the other hand, limited partners do not face these same problems because they enjoy limited liability. They are protected from the need to give up personal assets to help the company pay for its debts;
- Costs of Formation: Setting up an FLP involves contracts, estate planning, and tax planning issues. The future partners need comprehensive legal advice in all those areas before establishing such a partnership.
What Are Some Legal Issues Involved with Family Limited Partnerships?
Family limited partnerships must abide by local, state, and federal laws that govern partnerships. In general, one legal issue that may arise with any limited partnership is the termination of partnerships. As noted above, if a shareholder withdraws from a limited partnership, this action may have various legal implications for the former partner and the partnership.
In addition, while FLs are legal, they should not be used in a way that would be considered fraudulent or deceptive. For instance, a person cannot use the FLP structure to evade taxes or commit activities that constitute a white-collar crime. These can lead to business penalties and, in some cases, may lead to criminal charges as well.
A lawyer can provide assistance in the event that there are any disputes, conflicts, or legal issues involving FLPs.
Do I Need a Lawyer for Help with Family Limited Partnership Issues?
Some experts believe that having a financial advisor specializing in FLPs draft your FLP agreement and assist in planning the internal structure is critically important. You should consult a corporate lawyer in your area.
Your lawyer can review the benefits and disadvantages of the FLP structure with you and help you decide if it best meets your purposes. Whichever business structure you select, your lawyer can help form and prepare a partnership or operating agreement that works best for the needs of your business. Your lawyer can also keep you informed of any significant changes to the law that might affect your legal rights and options.
