- Family Limited Partnerships & Family Limited Liability Companies - Estate Planning Vehicles for the Masses
- May 19, 2003 | Author: David W. Woodburn
- Law Firm: Buckingham, Doolittle & Burroughs, LLP - Akron Office
For years, family limited partnerships ("FLPs") have been popular vehicles for commercial and residential developers, landlords, and ordinary real estate owners. More recently, the use of family limited liability companies ("FLLCs") has grown in popularity among this class of individuals. FLPs and FLLCs offer a range of advantages to real estate owners.
Typically, real estate owners create FLPs and FLLCs for liability protection. By carefully structuring and managing these business entities, owners can limit potential liability that may arise from lawsuits involving their real estate holdings. By limiting their liability to the value of their investments, owners are able to shelter their personal assets and other investments. This is especially important for individuals who own multiple real estate holdings that are developed and managed independently of one another. In such situations, if one development project has problems, all the rest do not suffer.
Aside from their ability to limit liability, both FLPs and FLLCs are uniquely suited to provide real estate owners with estate, gift, and income tax benefits that allow persons to pass wealth to future generations at a reduced rate. Real estate owners create such FLPs and FLLCs with the purpose of preserving and maintaining unified and consistent management of the properties that may be contributed to the entity. These entities also allow families to keep assets consolidated in a single location and provide a vehicle to foster the development of investment asset understanding and expertise within a family.
FLPs and FLLCs are also beneficial as investment entities; they facilitate the making of gifts because no transfers of cash or securities have to be made each time a gift is desired. Gifts can be made by simply executing an assignment of units, similar to a stock power used to make a gift of stock. Because each completed gift will be a gift of non-management units, the value of each conveyed unit will be a fraction of the percentage interest of the market value of the underlying entity assets that the gift conveys. This "discount" is created because the units given carry with them no management powers and no unilateral ability to sell or cash in the unit for full underlying asset value. Accordingly, this creates a valuation discount and provides gifting leverage in that it allows more underlying value to be given away than will be recognized for federal gift tax purposes.
To better illustrate the gifting aspect of the FLP and FLLC, I will use the following example: If one conveys $1 million into an FLP or FLLC and takes back 10 voting (management) units and 990 non-voting (non-management) units, each unit would have a percentage value of approximately $1,000 ($1 million divided by 1,000 shares). Based on the annual gift tax exclusion of $11,000, an individual could arguably give away 11 non-voting units without generating any adverse gift tax. However, under the terms of the management agreement governing the business entity, the non-voting units generally have no control over issuing dividends or the management of the company. Similarly, a gift of non-voting units is not attractive to an outside third party because the company is run by one family and the third party would own no controlling share in the company, thus making the interest less marketable. When these facts are coupled with the fact that there are generally restrictions on the transferability of interests to non-family members, then non-voting units are not very desirable to outside parties. Accordingly, it is appropriate to discount the value of each share to account for the lack of control and marketability. These discounts may range anywhere from 10% - 40% or more. Thus, these discounts allow you to pass on more than 11 units without exceeding the annual exclusion amount.
Individuals who are considering FLPs or FLLCs must be aware that the IRS does not like these entities to the extent they are used to achieve gift valuation discounts. Efforts have been undertaken by the Treasury Department to achieve a legislative repeal of these companies as an estate planning tool. Recent cases have suggested one must approach FLPs and FLLCs with great care in terms of drafting the restrictions and language contained therein. Notwithstanding the IRS scrutiny, FLPs and FLLCs continue to be viable estate planning techniques as long as the family is willing to live with the possibility that the IRS may challenge them and adjustments may have to be made with respect to any gift or estate taxes paid. Depending upon the circumstances, potential estate planning benefits to be derived from the FLP and FLLC typically outweigh the disadvantages, and when there is significant estate tax liability facing an estate, the risks are worth taking. When combined with the liability protection available, FLPs and FLLCs are a must for real estate owners to consider.