Family Limited Partnerships (FLPs): Definition & Tax Implications

Instructor: Martin Gibbs

Martin has 16 years experience in Human Resources Information Systems and has a PhD in Information Technology Management. He is an adjunct professor of computer science and computer programming.

This lesson will define a special business partnership, the family limited partnership (FLP), and discuss the tax implications/benefits of running an FLP.

The Family Limited Partnership (FLP)

A family limited partnership (FLP) is a type of business arrangement that is only applicable to family members. FLPs are usually set up by parents as the partners of the business who in turn transfer their share down to their children. The purpose of the arrangement is to ensure that the assets transfer down to the next generation with the lowest tax burden.

FLPs are formed under state law, and so there may be features among the different states. However, the core setup is similar:

  • At least two owners control the business: These are the partners in the partnership, called general partners
  • These partners have unlimited liability (think of a family farm; if you lose your farm, you lose everything)
  • An FLP is a partnership run by a family
  • Assets and control are passed on to the next generation(s)

In order to highlight the tax benefits of an FLP, let's consider the following scenario. You and your spouse (you are the general partners) run a cattle ranch in Texas that is set up as an FLP. The ranch is valued at $4 million.

You want to be able to pass the business on to your daughters and their children, but do so with the least amount of impact to your taxes. PLUS, you want to maintain control of the operation. You can decide to give each one 5% of the FLP. Since the ranch is valued at $4 million, a 5% gift would be $200,000 each, potentially subject to estate taxes. However, let's take a look at the unique tax implications of an FLP.

Tax Implications

Thankfully you will not have to pay estate tax on the full $400,000 of your interest transferred to your daughters. There are some discounts to be had here!

Lack of Control and Lack of Marketability

Tax law for FLP allows you to discount some of the property values under the clause of lack of control and marketability. This clause really means that you cannot easily sell your interest and (for now) your daughters aren't participating in the management of the ranch. These discounts are not set in stone; most fall around the 30% range.

There are a lot of numbers to think about. The following table highlights the tax impacts of an FLP, starting with our ranch's valuation at $4 million. Note that tax numbers may not be current; for real numbers, consult the IRS website or a qualified tax attorney! These are for illustration purposes only.

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