Brown & Associates - Attorneys & Counselors at Law, P.L.L.C.

Family Limited Partnerships and Limited
Liability Companies Have Benefits for Estate Planning Purposes
(4/08/01)

Last week, I talked about ways of passing on your family business to your children without having it eaten up by estate taxes. One thing I mentioned was the use of asset discounts to reduce the estate tax.

Afterwards, I was asked if these discounting techniques are only available for businesses, or if they can be used by anyone. The answer is an unconditional "yes."

Family Limited Partnerships (FLP) and Limited Liability Companies (LLC)

One way to qualify for asset discounting is to create either a family limited partnership or a limited liability company, or both. The family limited partnership is one in which the general and the limited partners are family members or family controlled entities, such as LLCs or trusts. A Family LLC is essentially the same - both the voting and non-voting interests are owned by family members or their trusts.

Why Would I Want to Set Up an FLP or LLC?

Parents are regularly faced with the dilemma of finding ways to give cash and assets to their children so they can reduce their taxable estates. The problem is that while the size of the estate is reduced, the parents have to give up control of the cash or assets. This problem can be eliminated with by using an FLP or LLC.

Quite simply, you put your cash, operating assets, investments, real estate, and other assets (but not your residence) into an FLP or single-member LLC In exchange, you receive a 1% to 10% general partnership interest in the FLP or a similar voting interest in the LLC. Since this will be the only general partnership interest or LLC voting interest issued, it will constitute 100% control of the entity. You will receive your remaining interest (90% to 99%) in limited partnership or non-voting interests.

You can now make annual gifts of a portion of your "general" and "limited" partnership or LLC "voting" and "non-voting" interest to your children, normally limiting the gift to $10,000 or less so you don't have to file a gift tax return. By gifting away part of your ownership interest, you now own less than 100% of the entity and qualify for the "lack of marketability" discount, too. This reduces the size of your estate for estate tax purposes.

At the same time, you have gifted away part of your "controlling" interest so the company also qualifies for a "lack of control" discount. The size of the discount will depend upon how much of the controlling interest you retained and how much you gifted away. If control of your assets is more important to you than qualifying for the discount, you can retain all of the controlling (general partnership or voting LLC interests), but this defeats one of the primary reasons for setting up the company in the first place.

You can continue to make annual gifts thereafter, further reducing the size of your estate each year and potentially increasing the discounts at the same time. In addition, if you want to, you can make sizable gifts up to the total amount of your federal exclusion ($675,000 in 2001). These gifts, however, must be reported on a federal gift tax return.

Who Should Be the General Partner or Voting Member of the LLC?

We usually like to have you create a separate entity to serve as the General Partner or Voting Member of your FLP or LLC. By using such an entity, there is no loss of control or continuity should you die or become incapacitated. In our office, we use Revocable Living Trusts or Limited Liability Companies as General Partners for FLPs, and Revocable Trusts as the Voting Members of LLCs.

Once the FLP or LLC is created, you can make gifts to your children or their irrevocable trusts. If you do, you may want to consider using a professional Trustee, such as a Bank Trust Department, or a responsible family member other than yourself as the Trustee of the Childrens Trusts.

What Assets Should Be Used to Fund the Partnership or LLC?

You should not fund these entities with retirement plans, S-Corporation stock, or personal use assets, such as your home or automobile. You also should avoid funding your FLP or LLC with annuities, stock options or assets which are heavily mortgaged. Other than that, you can put almost anything into the partnership, including cash, mutual funds, real estate, stocks and bonds, and certificates of deposit.

Some commentators recommend against putting a family business into an FLP, but I've never really understood their logic. For many of our clients, that is exactly the asset they want to put into their new entity.

If you don't want to put your family business into your FLP, you can always put some of the business assets (other than S-Corporation stock) into it and lease the assets back to the business. Finally, if you own stock in a family corporation, you can put it into the partnership, as well.

Next week I'll expand upon the tax advantages of using FLPs and LLCs as part of your estate planning.

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