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Use FLPs To Transfer Assets And Cut Estate Taxes

Despite recent court rulings, the family limited partnership—or FLP, pronounced “Flip”—remains a useful tool for wealthy individuals. Yet with the Internal Revenue Service on the lookout for abuse, you must proceed with caution and good legal advice.

For a typical FLP, you set up a limited partnership and transfer income-producing assets—perhaps a business interest or investment real estate—into the partnership. Those who contribute assets are named either the general partner (GP) or limited partners (LPs). The GP has control over assets and distributions, but for exactly that reason, his GP interest is subject to estate tax—and so he shouldn’t contribute the majority of the assets, and may want to consider a different estate planning vehicle altogether.

If you’re married, though, you could have your spouse contribute all of the investment assets as a limited partner, while as GP you still get to make partnership decisions. Future transfers of assets to children or grandchildren will come from your spouse’s shares.

Partnership earnings are paid out to the limited partners, who are taxed on the income. Assuming they’re in lower brackets than you are, less money ends up going to the IRS. And if you handle things properly, the assets transferred to the FLP are removed from your taxable estate.

The asset transfer to the FLP is a potentially taxable gift, but you can minimize liability with your annual gift tax exclusion and lifetime exemption. Under the annual exclusion, you may make gifts valued at up to $12,000 per year ($24,000 if your spouse also gives) to each recipient. You could use these amounts over several years for a tax-free transfer of assets into the FLP. Plus, everyone is entitled to an additional $1 million or so (this number changes frequently) in untaxed gifts over a lifetime, and that exemption can cover gifts exceeding the annual exclusion. Potentially even better, the value of FLP interests can be discounted by as much as 30% for estate and gift tax purposes, because limited partners can’t easily sell their shares. However, to be completely safe, you may want to keep annual gifts below the $12,000 threshold, because there’s a chance the valuation discount could be audited later and disallowed.

Keep in mind, too, that the IRS is inherently suspicious of such arrangements, and if an FLP doesn’t pass muster, all assets could end up back in your taxable estate. That’s what happened in a landmark case in which Albert Strangi, an elderly entrepreneur, transferred most of his assets to an FLP and named his adult children as GPs together with him. He claimed quite generous discounts on the value of the transferred partnership interests, and distributions from the FLP were used solely to pay Strangi’s personal expenses. The Fifth Circuit Court of Appeals eventually ruled that the FLP assets must be counted in Strangi’s estate.

Despite the Strangi case, however, FLPs may offer potential benefits for your estate. We can work with your tax advisors to structure a partnership that strictly follows IRS rules.

This article was written by a professional financial journalist for Legend Financial Advisors, Inc.® and is not intended as legal or investment advice.

©2018 Legend Financial Advisors, Inc.®. All rights reserved.