Using FLPs for Wealth Transfer and Estate Planning
There are a few different vehicles to consider when contemplating passing on wealth to the next generation. Two of the most effective yet overlooked techniques are: 1) establishing a family limited partnership (FLP) and 2) creating an intentionally defective grantor trust (IDGT). These are more complicated than just gifting away cash or assets, which is why some families tend not to think of them for their estate plan. In this article, we lay out the basic components of the FLP and how it could be used to ensure your estate planning is fully maximized for you and your family. In our companion article, you can learn all about IDGTs and how to use them.
What’s an FLP, and how can it be used to transfer wealth?
A family limited partnership (FLP) may be used as an estate planning tool to help families transfer their wealth to the next generations, all while maintaining control and management of the assets.
An FLP is a holding company with two or more family members in which family assets like publicly traded securities, privately held securities, real estate or family business interests are held. The FLP must be established for legitimate business reasons, but in addition to these business reasons, many families also create one as a vehicle to transfer their wealth to the next generation.
The FLP has two types of owners: general partners (GPs) and limited partners (LPs). GPs don’t need to own a majority of the FLP but can still retain control over the assets. GPs are also fully liable for the risks within the FLP and are responsible for the day-to-day management of assets owned by the FLP. LPs will typically (but not always) contribute capital to the FLP in exchange for shares in the assets but have no say in the management of the assets or any liability beyond whatever capital they’ve contributed.
Furthermore, within the FLP agreement, a clause may be included that severely restricts or prohibits the ability to transfer shares outside of the family, which is a useful feature for the originating generation who wishes to keep all the wealth within the family.
How can I pass down wealth using an FLP?
Once an FLP is established, the originating generation may transfer an asset into the FLP in exchange for shares of the FLP. There are two types of shares in the FLP: GP shares and LP shares. The originating generation will gift or sell LP shares, as they are less valuable than GP shares, and it allows them to maintain control of the asset. LP shares are considered less valuable because they lack marketability and control. Lack of marketability refers to the fact that LPs are unable to sell the asset outside of their family, while lack of control is the result of LPs having no say in the management of the asset.
These less-valuable LP shares allow the originating generation to gift or sell LP shares to future generations at a discount relative to their true market value. Another bonus is that the GP retains the ability to control the business but allows future generations to participate in the financial benefits of the FLP by shifting income from the GPs to the LPs (if done properly). Furthermore, once the assets are gifted, they’re considered frozen for estate tax purposes, and any corresponding appreciation of the assets is no longer included in the estate of the GPs.
Important considerations when creating a FLP
An FLP can be a great way to transfer your wealth to future generations, but it’s important to note that once you transfer assets into the FLP, it is an irrevocable decision. You’re no longer the owner of the asset—the FLP is—so, as such, you should consult with your Corient Wealth Advisor to ensure the assets you do retain will be enough to provide for the retirement lifestyle you intend to have.
Also, the FLP is a “pass-through entity,” meaning that any income and/or deductions the FLP produces will be passed through to each partner in accordance with their share of the FLP, either as GPs or LPs. Lastly, an FLP does not provide liability protection to the GP, so you may need to create another entity, such as a limited liability company (LLC), to offer liability protection to the GP.
Bottom line
The family limited partnership can be an effective estate planning technique to reduce a taxable estate and pass down wealth. However, it must be structured very specifically to ensure it’s implemented and maintained properly. If you’re considering this sophisticated technique for your estate plan, be sure to consult with a Corient Wealth Advisor in coordination with your tax professional and estate planning attorney.
ABOUT THE AUTHOR
Andy McNamara
Andy is a Wealth Advisor in our San Diego office. He joined legacy firm CI Dowling & Yahnke Private Wealth in 2020 as a Financial Planner. Prior to joining CI Dowling & Yahnke, he spent six years as an advisor and financial planner with two local investment management firms.
Andy holds the CERTIFIED FINANCIAL PLANNER™ certification and Certified Private Wealth Advisor® (CPWA®) and Certified Exit Planning Advisor (CEPA®) designations. He completed his Bachelor of Arts in Economics at the University of California, San Diego (UCSD).
Andy is a native of Southern California. He moved to San Diego to attend UCSD, where he was lucky enough to meet his future wife. They have lived in San Diego ever since and now have three daughters and a rescue dog.
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