The partners are members of the same family, but the partnership is created in such a manner that senior partners retainvoting control until the junior partners are ready to take on more responsibility. The personal assets of family members who are limited partners are not exposed to the partnership's liabilities. A family limited partnership must have at least two partners and at least one general partner.
Suitability of Family Limited Partnerships.
The family limited partnership should be considered an integral part in the estate planning for high net worth individuals with diversified assets of significant value who want to transfer interests in such assets to children, grandchildren, and others. At the same time, these individuals can retain control of asset management, cash, and distributions. There is no threshold amount or entry level at which consideration should be given to a family limited partnership. A family limited partnership may be warranted when there is likely to be estate tax payable at death, the death of the survivor, or the death of a spouse, which has not been provided for through life insurance or other sources.
A family limited partnership is also well suited for those with concerns about claims of future creditors. Generally, a limited partner creditors cannot reach assets owned by a family limited partnership unless the transfer to the partnership was a fraudulent conveyance. A creditor's remedy is limited to a charging order against the partner's interest, which only permits the creditor to receive the partner's share of distributions from the partnership. Since the general partner in a family limited partnership controls the tuning and amount of distributions, the value of the charging order may be greatly reduced.
Jurisdiction.
Family limited partnerships can be formed in many different jurisdictions. UK family limited partnerships are problematic for two reasons. Firstly, UK partnership law requires any partnership to be a proper business. An inactive asset holding/property holding family limited partnerships, as many will be, would not normally be a business within that definition. US partnerships are more attractive in this sense, as they have no such requirement. However, the US tax authority has been paying more scrutiny to family limited partnerships, so changes may be made that make US family limited partnerships less attractive.
Structure.
A family limited partnership is a limited partnership formed under a selected country's law. Normally, a family limited partnership must have at least one general partner and will typically have several limited partners. The general partner is vested with sole authority to manage the partnership's everyday activities. The limited partners are prohibited from engaging in the entity's day-to-day management, but they may have voting power for certain fundamental decisions. The rights of the general and limited partners will be specified in the partnership agreement.
In a typical family limited partnership, the senior-generation family members will transfer family business and/or other property interests to form the partnership. The senior-generation partners maintain control of the distributions and management by holding the general partnership interest either directly or through a controlled entity, such as a corporation or trust. Limited partnership interests will be transferred to the junior-generation partners by sale or gift to shift wealth to the next generation.
On a pro-rata basis, the partnership interests are worth less than the value of their underlying assets because they are illiquid, and the holder of a proportional interest lacks control. The most alluring feature of a family limited partnership is this ability to discount the value of the assets put into the partnerships because the shares distributed from it are less liquid since only another family member can buy them. This reduction in value enables a couple to transfer more of the estate's value to family members without triggering a gift tax. They may also retain control over the assets by designating themselves as the general partner. While there are limitations to this technique, the benefits are considerable.
The partnership agreement usually governs how partnership income is divided among the partners. It also specifies the manner in which the family limited partnership will be managed and its business conducted. Control over these functions is vested in the general partner, and the limited partners are typically given no right to participate, although they are given the right to vote on certain important matters. Control of the family limited partnership (through the corporate general partner) by the donor of limited partnership interests should not cause such interests to be included in the gross estate of the donor, provided the partnership agreement does not eliminate or significantly reduce the fiduciary standards imposed upon general partners under state law and the family limited partnership is actually managed in a manner consistent with such standards. However, excessively restrictive provisions may make gifts of family limited partnership interests ineligible for the gift tax annual exclusion because they are not present interests. Moreover, retention of control over the general partner on the death of the donor may cause the, estate tax value of the donor's remaining family limited partnership interests to be determined based upon the value of the partnership's underlying assets without regard to valuation discounts. Generally, both the general and the limited partners will share in income and cash flow based on their respective share or percentage of interest in the partnership. Members of a family limited partnership are taxed on their share of profits but the partnership itself has no taxable presence.
Benefits.
The main advantage of using a family limited partnership is for wealth planning purposes. As part of establishing a partnership, property and assets are transferred into the partnership. Frequently this involves a transfer tax. Because of the lack of an established market for the sale of limited partnerships, not to mention the lack of control that limited partners have, the limited partnership interests are often valued at a iscount for transfer tax purposes. The tax benefit of the discounted value of the partnership interests, coupled with significant non-tax benefits such as liability protection and centralized management, has contributed to the popularity of the family limited partnership as does the ability of the contributing partner to participate in the management of the partnership as a general partner.
Another advantage is that a family limited partnership allows the transfer of assets out of your estate, while still allowing the managing partner (the general partner) to retain control of those assets. As the use of the partnership's assets is set out in the partnership agreement, this gives more control over how transferred assets are used, compared to gifting them or leaving them to beneficiaries in a will. Neither general partner's creditors (nor those of participating family members) can seize their partnership interest, dissolve the partnership, or sell the assets of the partnership to satisfy their debts. A creditor of a partner can receive only the partner's right to partnership profits. This means that the greatest interest such a creditor can hold is the partners' right to income distributions from the family limited partnership and, of course, the decision to make distributions is determined by the family partners. Simply put, the family limited partnership allows general partners to retain control even after the family assets are insulated from estate taxation and creditors of family members.
Yet another advantage of family limited partnerships is control and tax planning of family businesses across different jurisdictions. The structure is most suited to families owning large multi-jurisdictional businesses where individual family members will often be resident in multiple jurisdictions for reasons of work, study, family and perhaps wider economic and political reasons. Exposure to multiple legal systems, tax rates and risk factors requires a flexible but robust asset protection or succession planning vehicle for the family assets.
Managing a Family Limited Partnership.
Creating and maintaining a family limited partnership is expensive, and advisers, including attorneys, accountants, financial planners, and appraisers should be consulted in setting it up. Costs will be incurred for an appraisal of assets transferred to the family limited partnership and for professional valuations that determine the appropriate discount factors. Transfer taxes may also be incurred in transferring real estate to the family limited partnership. In addition to document preparation fees, the services of an estate planning or tax attorney must be retained to monitor the uncertainty of the family limited partnership climate because tax authorities, especially in the US, have become more skeptical of these entities.
Family limited partnerships are typically comprised of one or more partnerships through which a family may invest in marketable securities or illiquid alternative investments. The characteristics of these partnerships, such as allocations of income and distribution of cashflow, vary greatly depending on the asset classes in which the partnerships invest.
A family limited partnership that invests in illiquid asset classes, such as private equity, real estate, or oil and gas, typically will require partners to commit to contribute capital for a fixed percentage of ownership in the entity. The family limited partnership receives capital contributions from the partners as the underlying investments issue draw requests against the family limited partnership's commitments. Distributions to partners are made only when underlying investments generate distributable cashflow from operations or when a liquidity event occurs. There is little or no flexibility to admit a partner to the family limited partnership or participate in an underlying investment once initial commitments are made, because allocations of taxable income and loss, as well as cash distributions, are typically required to comply with the percentages fixed in the partnership agreement at the date of formation.
To enable partners in family limited partnerships to invest in different asset classes, family limited partnerships are often organized with multiple divisions or "side pockets." A side pocket is a separate accounting division within a partnership that is not intended to be a separate legal entity for tax purposes. As a division of the family limited partnership, the side pocket must maintain a separate balance sheet, including partner side-pocket capital accounts and a separate profit-and-loss statement. Allocations of side-pocket economic and taxable income or loss are made only to those partners that have designated a portion of their investments to the side pocket. The benefits of side pockets include reduced tax compliance costs and increased flexibility to rebalance investments within a single investment vehicle.
Consistent with minimizing gift tax consequences, the value of family limited partnership interests transferred annually should be less than the annual gift tax exclusion available. The gift of a family limited partnership's interest usually receives a significantly lower valuation than an outright gift of the underlying assets, thereby increasing the amount of the partnership interest that can be gifted and still be covered by the annual exclusion.
A Wise Choice.
Creation of a family limited partnership can be a very powerful tool for those who are seeking avenues that provide tax efficiency when they are giving gifts to family members.
