My Dad always said “Never do business with family members”.
Lots of wealthy and not so wealthy people are totally ignoring this advice. Family limited liability companies (LLC) or family limited partnerships (FLP) are being used by many families as part of their overall estate planning. As noted in our lifestyle story on Sam and Helen Walton, they set up a partnership for their family. This is a complex area of estate planning with ongoing IRS challenges and legal changes, consult a professional.
What are family partnerships?
An LLC or a limited partnership is a legally recognized entity. An LLC made up of members and possibly managers can function similar to a limited partnership. A limited partnership has one or more general partners (who make all the decisions) and one or more limited partners (who own partnership shares but don’t participate in management).
Typically, a mother and father set up a partnership, making themselves the general partners and the children limited partners and funding the partnership with assets. The parents then gift the children each year (up to the exclusion amount, or more if they choose) with units of the partnership.
Benefits of using a family partnership.
Income taxes can be lower, units owned by the children are taxed at the child’s rate.
Estate taxes can be lower, partnership units placed in the children’s names are gifts and thus removed from the parent’s estate.
Estate taxes can be lower, the units are transferred to the children before the underlying assets in crease in value. All of the appreciation of the underlying assets is not subject to estate tax
Gift taxes might be lower, limited partnership units might be ‘discounted’ from the value of assets the units represent. This is because the limited partnership places restrictions on the assets that make them less marketable.
Protection from creditors.
If a creditor comes after a limited partner, assets owned by that partner under the partnership cannot be directly accessed by the creditor (since the limited partner does not manage or control the asset). The only thing the creditor can do is get what is called a ‘charging order’. A charging order lets the creditor get the distributions from the partnership – as the limited partner would. However, in most states, the creditor cannot go after the limited partner’s share in the partnership.
Training for the next generation and facilitation of succession.
Because the parents and children are in partnership, children may learn more about managing the assets in the partnership.
The children may at some point take over general partner duties, managing the assets for the parents.
An experienced or professional manager can centrally handle finances for multiple family members and generations.
Expanded investment opportunities.
It is possible to have different classes of units or shares in a partnership or LLC. This can allow for different family members to have different allocations of investments. As an example, the partnership might have units that invest in growth assets and units that invest in income assets. Different family members, at different stages in their lives might like to have different classes of units.
What to be cautious about when using a family partnership.
IRS audits and lawsuits.
There have been multiple challenges to reduction in estate or gift taxes by the IRS. Families with limited partnerships that discount the gifts to the limited partners stand a higher chance of being challenged by the IRS on that discount.
Failure to execute, fund or maintain the partnership or LLC properly.
In either an LLC or a partnership, there are certain particulars that must be observed. For instance, both require an operating agreement (called a partnership agreement in a partnership). The agreement must be followed. There must be a distinct separation between the LLC or FLP and the individual. The LLC or FLP must in fact be treated as a separate entity.
Feuds in the family due to the LLC or partnership.
Pursuant to my Dad’s advice at the beginning of this article, if your family does not function well, you can count on disagreements about a partnership or LLC. The disagreements can cause lasting damage to family relationships unless you are able to handle them successfully as a family.
Extra expenses and time are typical.
Partnerships and corporations cost money to set up. Partnerships require a yearly fee to the state. Both involve services from a lawyer to set up the operating agreements. Each must file a tax return and each requires due fiduciary care to make sure they are operating to the satisfaction of the law and the partners/members.
“Is A Family Limited Partnership the Right Estate Planning Tool for You?” from babyboomer.com by
“Protect your Family with a Partnership” from MSN.com by Jeff Schnepper
“Family Investment Partnerships: Structure, Design, Issues, And Problems (Beyond The Valuation Discount)” by Paul S. Lee
“It’s Never Too Early” Janet Novack. Forbes. New York: Oct 30, 2000. pg. 294
“Keeping the Peace” Joanne Gordon and Matthew Swibel. Forbes. New York: Dec 10, 2001. Vol. 168, Iss. 15; pg. 146