Martin M. Shenkman, CPA, JD, MBA, PFS, AEP (distinguished), estate- and tax-planning attorney based in New York City. He is coauthor of Powers of Attorney: The Essential Guide to Protecting Your Family’s Wealth. ShenkmanLaw.com
Do you think a Family Limited Partnership (FLP) is something that you don’t need to consider? Maybe…maybe not.
FLPs—a type of business entity owned by multiple members of a family or by a trust—are widely used to operate businesses or investments…for asset protection…and sometimes to move wealth from one generation of a family to another. They also can be tools to shift income tax or to reduce gift and estate taxes.
While the federal lifetime gift-tax exemption is a lofty $12.92 million in 2023, an FLP isn’t a tool that many families currently need for estate-tax reduction. But: Estate taxes could be back on the table relatively soon—that $12.92 million exemption is slated to be slashed in half in 2026, though it will be adjusted for inflation.
So even for families that are unlikely to ever face estate taxes, FLPs may be worth a look. Helpful: Limited liability companies (LLCs) are, in many ways, comparable to FLPs and, in fact, have become popular in recent years.
An FLP can provide asset protection without sacrificing control. There are two classes of owners for an FLP—general partners and limited partners.
The limited partners have an economic interest in the partnership but do not have any control over it. They often are the children and grandchildren of a general partner and receive significant liability protection. A limited partner’s creditors or a divorcing spouse may not reach the limited partner’s share of FLP assets. Even better: Have the limited partner’s interests for heirs held in a trust. (See below for more about this.)
General partners have an economic interest in the FLP but typically don’t enjoy liability protection—but there are ways to achieve that liability protection. Example: An LLC or S Corp could be established to serve as general partner, and the general partners—the parents—can maintain control of the LLC or S Corp.
An FLP might not provide the intended upsides if you make any of the following mistakes (these apply to LLCs, too)…
Mistake #1: Holding multiple businesses or rental properties in the same FLP. When people do this, a creditor or lawsuit that affects one of the holdings can trigger a domino effect that leads to the loss of all of the holdings. Better: Have a separate FLP/LLC created to hold each business or rental property.
Mistake #2: Using an FLP to pay personal expenses. An FLP’s asset protection and tax advantages can be lost if money is used by the FLP to pay personal bills unrelated to the rental property, business or other assets that it contains.
Mistake #3: Obtaining personal homeowners insurance for an FLP-owned rental property. Insurers may charge higher rates to cover rental properties than they do for owner-occupied properties, and that may tempt some property owners to be less than honest about how their rental properties are used. But that can be a very costly mistake—not only might the insurer refuse to pay claims if it discovers the deception, this mixing of personal and FLP finances could cost the property owner the asset protection that the FLP was meant to provide.
Mistake #4: Retaining control over distributions or liquidation. If the parents’ goals include removing FLP interests from their estate or the reach of creditors, they should not retain any control over the distributions from or liquidation of the FLP.
Mistake #5: Having children own FLP interests directly. It is estimated that about 40% of marriages in the US end in divorce. Kids may be irresponsible and get into a car accident or sued…or they might not mature as anticipated. The safer approach is to have the FLP interests held in a trust for the children. That can provide protections for them and assure the parents better control. Example: If the FLP makes a pro-rata distribution to partners, what if one child is immature or facing a divorce? If the FLP interests are held in trust, the trustee can give the other children their shares of the distribution but hold the worrisome heir’s share until his/her issues are resolved.