Tansey Estate Planning

Protecting You and Your Loved Ones

Family Limited Partnerships and Family Limited Liability Companies

Family Limited Partnerships (“FLP”) and Family Limited Liability Companies (“FLLC”) are ordinary Limited Partnerships and Limited Liability Companies with family members. Limited Partnerships and Limited Liability Companies are creations of state law. Both the FLP and the FLLC allow a person with a small interest in the entity to control the entity. This is different than a corporation. Normally, both the FLP and the FLLC are taxed as partnerships, which only have one level of income taxation. Again this is different from a C-Corporation, which has two levels of income taxation. FLPs and FLLC’s provide an excellent non-tax reason for their creation: both entities provide some asset protection.

An FLP has two classes of partners: the General Partner who controls the partnership; and the Limited Partner who is essentially an investor in the partnership. The General Partner has unlimited liability, so most General Partners form an entity that provides limited liability such as a corporation. State law provides that Limited Partners have limited liability. The FLP is operated under the FLP agreement which provides: the term and purpose of the Limited Partnership; the working relationship between the General Partner and the Limited Partners; the powers of the General Partner; the rights of the Limited Partners; the economic relationship between the Limited and General Partners; the tax consequences of operating the FLP; the right to transfer partnership interests; and how to dissolve the FLP.

An FLLC has a much simpler structure. The FLLC has Members, and is controlled by the Manager. An FLLC can have all members act in the role of Manager, and all of the Member/Managers will have limited liability. However, for Estate Planning purposes, the FLLC will have a Manager that controls the FLLC and Members who act as investors (similar to the Limited Partner in the FLP). In fact, with an FLLC, the Manager does not have to be a Member of the FLLC. The FLLC is operated under the FLLC operating agreement which provides: the term and purpose of the Limited Liability Company; the working relationship between the Manager and the Limited Partner; the powers of the Managers; the rights of the Members; the economic relationship between the Manager and the Members; the tax consequences of operating the FLLC; the right to transfer membership interests; and how to dissolve the FLLC.

Most FLP Agreements and FLLC Operating Agreements vest control in the General Partner or Manager and restrict the transferability of Limited Partnership or Membership interests. Therefore, Limited Partnership and Membership interests will receive a valuation reduction as compared to those pro-rata interests’ in the underlying FLP or FLLC. However, the IRS will not recognize any restriction in the FLP Agreement or FLLC Operating Agreement, which is more restrictive than provided under state law. Congress is reviewing eliminating any valuation reductions for any Limited Partnership or Limited Liability Company where all the participants are members of one family.

In the Estate Planning context, the senior family members gift or sell Limited Partnership or Membership interests to the junior generation. This allows post-transaction appreciation to accrue to the junior generation. Therefore, both entities are Freeze transactions. However both entities must be run as a business and not the personal bank of the creator of the entity. Both entities must have a good set of books and follow all the business formalities in operating the entity. If the IRS discovers that either entity is paying for the personal expenses (including estate settlement expenses or Estate Taxes) of the senior family member after the sale or gift of limited partnership interests, the value of the gifted or sold interests will be brought back into the senior family member’s taxable estate.