The Advantages of Family Limited Partnerships
Compass On Business Feature

In our last issue, we also discussed the "Values and Vision in Transitioning Wealth." In this article, Mary Margolis, a principal with Stavis, Margolis Advisory Services, Inc., a Houston financial advisory firm owned by Compass Bank, helped outline some of the key non-financial issues you need to think about when working with your heirs to ensure that the wealth you’ve built in your business works to serve them going forward.

If you’re looking for a financial structure to serve the process, a Family Limited Partnership (FLP) might work for you. In an FLP, there’s a general partner, typically the parents, and limited partners. The FLP partners transfer title of personal assets, such as a business, marketable securities and real estate, into the partnership in exchange for an ownership interest.

"In an FLP, the general partner, who generally holds the smallest equity, often at around 1% or 2%, calls all the shots regarding the management, buying and selling of assets and determines what cash, if any, is distributed," adds Margolis.

FLP investments are subject to several restrictions: they can’t be pledged to secure a loan, the limited partner has no ability to force cash distributions and the limited partners can’t sell their interest without the consent of the general partner(s). However, because of this lack of marketability and liquidity, the assets in an FLP have less value. As a result, while making gifts during your lifetime, or for limited partnership interests you hold at your death, certain discounts may apply for the purpose of calculating gift or estate taxes.

"The discounts are a desirable by-product, but the main reasons for establishing an FLP include consolidation of family wealth in diverse assets, creditor protection for the assets held in the partnership and providing a vehicle to help facilitate gifting to children, as well as preparing adult children to manage the FLP," Margolis asserts. In addition, consolidation of multiple family investment accounts in the FLP may lower the aggregate investment management fees.

Other FLP benefits include:

• The creditor protection provided by the FLP extends to all limited partners. If one is sued for any reason, the creditor may never become an assignee of the partnership. Rather, they issue a charging order, which allows them to receive funds only if the general partner decides to distribute cash flow. If the general partner opts not to make a distribution of cash, the creditor would have phantom income for the prorated share attached. In that case, a tax liability without commensurate cash flow typically motivates the creditor to settle.

• When gifting fractional interest in real estate to children or grandchildren, changing title may be difficult and might require re-plotting of property. An FLP can let you gift various percentages of a property without having to physically divide it. An FLP can also enable you to gift assets outside of your taxable estate while you still maintain control of the management.

• Perhaps the greatest benefit of an FLP is as a tool to teach your children and grandchildren to be good stewards of family wealth. Being a partner in the transaction allows for involvement in the process early on and prepares them for decision-making later. The parents can give the children more responsibility and eventually appoint them as general partner(s), if desired. "It’s a great mechanism to help adult children to become good stewards of family assets and effectively interact with a team of advisors," observes Margolis.

One note: Margolis advises exercising caution regarding what you place in an FLP. "Remember, the FLP is really a business and you need to respect it as such. It shouldn’t be used as a personal bank account and large regular distributions can negatively impact the discount," she says.

When you set up an FLP, Margolis advises documenting all the objectives you want to achieve. "There are so many benefits associated with FLPs that you shouldn’t focus solely on the tax and gifting advantages," she notes. "When you create an FLP, bring all your advisors into the picture—financial, legal, tax accounting, etc. You need to work with your team and look at your situation from the perspective of all the different disciplines you use. Don’t go it alone. Meet with your entire team at least once annually, if not quarterly. You need to make sure you’re all on the same page regarding the ongoing administration of your FLP."

Stavis, Margolis Advisory Services, Inc. offers securities through FSC Securities Corporation, member of NASD, SIPC and a broker-dealer member of AIG. Investment advisory services offered through Stavis, Margolis Advisory Services, Inc., a registered investment advisor not affiliated with FSC or AIG.

Compass Bank and Stavis, Margolis Advisory Services, Inc. do not provide tax services or legal advice. Proposed estate planning strategies should be reviewed by your legal and tax advisors. The examples used in this article are illustrative only and are not intended as tax advice.