Family limited partnerships (FLPs) are an estate planning tool that reduces estate, gift, and income tax liabilities by allowing families to transfer a significant amount of their wealth to the next generation. Unfortunately, this popular and effective estate planning tool is being challenged by the current administration in Washington, D.C.
Understanding Family Limited Partnerships
An FLP is a business entity created following state law and used to hold and manage property. There are two types of partners in FLPs.
General partners own the largest share of the business, handle day-to-day management tasks, and are liable for the partnership’s debts and liabilities. In a family-owned FLP, parents are the general partners, which means they can continue to manage the property.
Limited partners have no management responsibilities and do not share liabilities with the partnership. The limited partner is generally insulated from the partnership’s liabilities, and the partnership is insulated from the limited partner’s liabilities. State laws generally protect the property within the FLP from lawsuits against the limited partners.
Creditors rarely have the right to inspect the partnership’s books, vote as a limited partner, make management decisions, or force the sale of a limited partner’s interest in order to pay the creditor. Creditors may have the right to receive the partnership profits and distributions payable to the limited partner who is being sued. Trusts can be used to provide additional asset protection.
Partners can be individuals or entities, such as trusts or limited liability companies (LLCs). Children are limited partners, so they can benefit from the income the property generates and learn how to manage it without any current management responsibilities.
How FLPs are Used in Estate Planning
FLPs allow parents who own property, such as real estate or business interests, to retain control and management of their assets while beginning the process of transferring the property to their children for transfer tax purposes. In addition, the partnership options allow parents to use LLCs and trusts as partners in the FLPs.
The parent transfers their property into the FLP and then gift shares or partnership interests in the FLP to their children. They can do this all at once or slowly over time. Each year, parents can gift FLP interests tax-free to their children, up to the gift exclusion maximum. A secondary tax benefit is that the Internal Revenue Service acknowledges that, when the partnership interests are divided, they have a lower overall value than when a single individual owns them. This can result in significant tax savings.
The Biden Administration and FLPs
In the spring of 2021, the Biden administration released the General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals, also called the “Green Book”. This document explains proposed tax law changes planned by the Biden administration to raise revenue.
One proposal in the Green Book that may impact FLPs is a proposal to impose capital gains taxes on property transferred into an FLP that has appreciated in value. This proposal would be effective on January 1, 2022, is retroactive for 90 years, and applies to any property in an existing FLP that has appreciated in value. Identifying any property that has appreciated in value and is subject to capital gains tax would trigger a “recognition event.” According to the Green Book, the earliest date for these recognition events is December 31, 2030.
As an example, if a person purchased one hundred shares at an initial value of $1.00 and a current value of $101 of stock 89 years ago and transferred it to an FLP, under the proposed law, the transfer would trigger a recognition event, and $10,000 would be subject to capital gains tax.
Exclusions for the Green Book Proposed Law on Family Limited Partnerships
The following are proposed exclusions:
- Transfer to a spouse or charity would not trigger a recognition event.
- Capital gains on tangible personal property would be excluded.
- Exclusions for certain small business stock would remain in effect.
- The $250,000 personal residence exclusion on capital gains per person would continue to apply and would be transferable to a surviving spouse.
- A new $1 million capital gains exclusion per person can be used for appreciated property transferred by gift or passed at death. If one spouse passes without using their $1 million exclusion, it can be transferred to the surviving spouse, potentially shielding $2 million in gains per married couple.
- Family-owned or family-operated businesses could have up to fifteen years to pay taxes after recognizing the gains. They can delay recognition until they no longer own or operate the business.
As mentioned, these are proposed changes. We will be following them closely and will be ready to help you make any necessary changes in your estate planning for real estate and other assets. If you are interested in learning more about FLPs and their benefits, we encourage you to contact us.