Family Limited Partnerships & Estate Planning: Key Considerations for High-Net-Worth Families

The Tax Cuts and Jobs Act (TCJA) of 2017 introduced several provisions that are set to expire at the end of 2025. One of the most significant changes on the horizon is the reduction of the estate tax exemption. 

As of 2024, estates valued up to $13.61 million are exempt from federal estate taxes. Unless Congress takes action, this exemption is expected to decrease to $5.6 million per individual in 2026.

In anticipation of this potential change, families looking to preserve their wealth may want to consider establishing a Family Limited Partnership (FLP). While FLPs offer robust asset protection and a tax-efficient method for transferring wealth across generations, a thorough understanding of their rules and nuances are essential to make the most of this powerful yet complex estate planning strategy. 

Understanding Family Limited Partnerships

A Family Limited Partnership (FLP) is a unique legal entity designed to protect family assets and facilitate the transfer of wealth between generations. These structures are composed of two distinct types of partners, each with specific roles and responsibilities.

• General Partner(s). General partners have primary control over the FLP’s assets and make key decisions about its operations. Senior family members typically take on this role, managing the partnership’s day-to-day activities and assuming full responsibility for any debts or obligations incurred by the FLP.
• Limited Partner(s). Limited partners have a financial interest in the partnership but play a minimal role in its management. Their financial risk is capped at the amount they’ve invested in the FLP. This role is often filled by younger family members or trusts established for their benefit.

Ultimately, an FLP allows families to maintain control of their assets while gradually transferring wealth to the next generation in a tax-efficient manner. 

Consider the following example: 

Robert and Susan Jones are successful business owners nearing retirement. To protect their family assets and transfer them to their children in a tax-efficient manner, they establish the Jones Family Limited Partnership. 

As general partners, Robert and Susan contribute $5 million in real estate and investments to the FLP, retaining 2% ownership and full management control. They divide the remaining 98% among their three adult children. As limited partners, each child owns a 32.67% interest in the FLP but has no input in its daily management.

Over time, Robert and Susan gift portions of their children’s FLP interests, utilizing annual gift tax exclusions. This strategy allows them to gradually transfer wealth while minimizing estate taxes.

The FLP structure protects the family’s assets, shielding the limited partners’ personal assets from potential creditors. It also allows Robert and Susan to maintain control of their wealth while teaching their children valuable financial management skills. 

Key Benefits of FLPs

Family Limited Partnerships (FLPs) offer several significant advantages in estate planning. These include: 

• Asset Protection. FLPs provide a strong shield for family assets. By transferring assets into the partnership, they gain protection from personal creditors, offering security against financial challenges, legal disputes, and divorce.
• Gift Tax Savings. Transferring partnership interests to family members can benefit from valuation discounts, reducing the taxable value of gifts and allowing for larger transfers within annual gift tax exclusion and lifetime exemption limits.
• Estate Tax Reduction. FLPs can decrease estate taxes by dividing ownership among family members. The gradual transfer of limited partnership interests to heirs over time reduces the value of the general partners’ taxable estate.
• Income Tax Benefits. FLPs can allocate income among partners, potentially shifting income to family members in lower tax brackets. They may also utilize business-related deductions and tax treatments, further reducing taxable income. 
• Control and Wealth Transfer. FLPs allow experienced family members to maintain control over assets while gradually transferring wealth to younger generations. This structure ensures continued guidance of the partnership’s direction during ownership transitions.
• Business Succession. FLPs provide an effective framework for smooth transition of family businesses, helping preserve legacy and ensure continuity across generations.

By leveraging these benefits, families can create a comprehensive estate plan that protects assets, minimizes tax burdens, and facilitates efficient wealth transfer while maintaining control over family resources.

Potential Drawbacks of FLPs

While Family Limited Partnerships (FLPs) offer numerous benefits, it’s crucial to consider their potential drawbacks before incorporating them into your estate plan. These include: 

• Complexity and Cost. Establishing an FLP requires careful planning and expertise from legal and financial professionals. This expertise comes at a significant cost, generally ranging from $8,000 to $15,000 or more depending on location and partnership complexity. Additional expenses often include annual operating costs, tax filing fees, and appraisal charges. 
• Administrative Burden. FLPs demand ongoing management, including maintaining separate financial records, filing annual tax returns, and conducting regular partnership meetings. Neglecting these responsibilities could compromise the legal and tax benefits of the FLP.
• IRS Scrutiny. The Internal Revenue Service (IRS) closely examines FLPs, particularly those appearing to prioritize tax avoidance over legitimate business purposes. Proper structuring and operation of your FLP is essential to withstand potential audits.
• Asset Valuation Challenges. Accurately valuing the assets that you transfer into the FLP is vital. Professional appraisals are often necessary, as incorrect valuations can lead to tax issues and potentially negate the intended benefits.

Despite these challenges, many families find that the benefits of FLPs outweigh the drawbacks. By working closely with experienced professionals and maintaining meticulous records, it’s possible to navigate these potential pitfalls and maximize the advantages of your FLP. 

When Does an FLP Make Sense?

While FLPs are often associated with the ultra-wealthy, they can be suitable for a broader range of individuals and families with substantial assets and a long-term wealth management perspective. Examples include: 

• High-Net-Worth Families. Those with substantial assets seeking to protect their wealth and efficiently transfer it to heirs may find FLPs particularly valuable.
• Family Business Owners. Entrepreneurs who have built successful businesses and wish to keep them within the family can benefit from FLPs. This structure provides a framework for gradual ownership transfer to the next generation while maintaining control. It also offers asset protection and facilitates smooth succession planning.
• Individuals with Complex Estate Planning Needs. The flexibility and control offered by FLPs can be especially useful for those with diverse asset portfolios, multiple heirs with varying levels of financial expertise, or specific wealth management and distribution goals. 

Regardless of your circumstances and objectives, the key is to have enough assets to justify the costs and complexity associated with establishing and maintaining an FLP.

Steps to Establish a Family Limited Partnership

Establishing a Family Limited Partnership (FLP) requires careful planning and execution to ensure it provides the intended benefits. The process typically involves the following steps: 

1. Consult with experienced professionals. Begin by assembling a team of experts, including an estate planning attorney, a tax advisor, and a fiduciary financial planner. FLPs are complex structures with significant legal and tax implications, so professional guidance is key.
2. Determine the partnership structure. Work with your advisors to design the FLP structure. This includes selecting general and limited partners, determining ownership percentages, and choosing which assets to transfer into the FLP.
3. Draft and file legal documents. Your attorney will prepare the necessary legal documents, including the partnership agreement, which outlines the rights and responsibilities of all partners. These documents must be filed with the appropriate state authorities.
4. Fund the partnership. The final step involves valuing and transferring the selected assets into the FLP’s ownership. This process may require professional appraisals for complex or unique assets.

It’s important to note that establishing an FLP is just the beginning. Ongoing management and compliance are essential to maintain its benefits and legal standing. 

Additionally, clear communication with family members throughout this process is key. All involved parties should understand the purpose of the FLP, their roles within it, and the long-term vision for family wealth management.

Best Practices and Considerations

While Family Limited Partnerships (FLPs) can offer numerous benefits, it’s crucial to approach them with caution and adhere to best practices to avoid potentially costly pitfalls. To ensure the effectiveness and legitimacy of your FLP, consider the following guidelines:

• Establish a legitimate business purpose. Your FLP should have a clear, legitimate business purpose beyond tax savings to withstand potential IRS scrutiny. This purpose should be well-documented and consistently pursued throughout the partnership’s existence.
• Maintain proper documentation. Be sure to keep meticulous records of all FLP activities, including financial transactions, asset valuations, and partnership meetings. This documentation is essential for demonstrating the FLP’s legitimacy and proper management.
• Hold regular meetings. You’ll need to conduct and document regular partnership meetings to discuss FLP business and make important decisions. These meetings help demonstrate that the FLP is actively managed and not merely a tax avoidance strategy.
• Avoid commingling assets. It’s important to strictly separate personal assets from partnership assets to maintain the FLP’s integrity and protect its legal standing. Mixing personal and partnership funds can jeopardize the FLP’s effectiveness and invite IRS scrutiny.
• Ensure proper asset valuation. Be sure to accurately value all assets transferred into the FLP, especially complex or unique assets. Professional appraisals may be necessary to support these valuations in case of an IRS audit.
• Be cautious about dissolution. If you decide to dissolve an FLP after its creation, be aware that the process can be complex and potentially costly. You may face significant tax consequences, particularly if substantial appreciation has occurred since the FLP’s formation. Always consult with legal and tax professionals before making such a decision.

FLP Alternatives 

While Family Limited Partnerships (FLPs) can be powerful estate planning tools, several alternatives exist that might better suit your specific family circumstances or financial goals. For example:

• Trusts can be an excellent option if your primary objective is to provide for minors or individuals with special needs. 
• Limited Liability Companies (LLCs) might be preferable for those seeking simpler management structures or greater flexibility in profit distribution. 
• Direct gifting strategies could be sufficient for individuals with smaller estates and simpler transfer goals. 

Ultimately, the most effective wealth transfer strategy for one family may not be ideal for another. To make an informed decision, it’s essential to thoroughly understand your available options and how they align with your specific objectives and values. 

TrueNorth Wealth Is Here to Help

Family Limited Partnerships (FLPs) offer a range of significant benefits for estate planning. However, FLPs are also complex legal entities that require careful consideration, meticulous planning, and ongoing management to maintain their benefits and legal standing.

Given their complexity, it’s wise to seek expert guidance when considering an FLP. Experienced estate planning attorneys, tax advisors, and financial planners can provide valuable insights and help determine if an FLP aligns with your family’s specific needs and goals.

If you’re looking for personalized guidance in developing your family’s estate plan, TrueNorth Wealth is here to help. Our team of fiduciary CFP® professionals will work with you to create a comprehensive plan designed to preserve your wealth and secure your legacy. 

TrueNorth Wealth is among the top Wealth Management firms in Utah and Idaho, with offices in Salt Lake City, Logan, St. George, and Boise. At TrueNorth Wealth, we focus on helping our clients build long-term wealth while maximizing the enjoyment they receive from their money. We do this by pairing our clients with a dedicated CFP® professional backed by an incredible team.

For our team at TrueNorth, it’s about so much more than money. It’s about serving families all across Utah and helping them achieve freedom and flexibility in their lives. To learn more or schedule a no-cost consultation, visit our website at TrueNorth Wealth or call (801) 316-1875.