A Family Limited Partnership (FLP) is a type of limited partnership where family members pool money into a family business. In doing so, each family member owns shares in a business, which means they assume ownership of the business. The partnership divides profits, dividends, and/or interest between two or more family members.
All the partners are family members who are defined to be an individual’s spouse, ancestors (i.e., parents and grandparents), as well as lineal descendants (i.e., children and grandchildren).
Types of Partners
The two types of partners in a family limited partnership are general partners and limited partners.
General partners are the owners of the business with the largest shares, and they also take part in managing the day-to-day aspects of the business, such as handling money at the cashier or hiring new employees. They are involved with management decisions and executive responsibilities. Additionally, they retain full control of the business’ assets.
On the other hand, limited partners are individuals who also own a part of the business, but they do not take part in the day-to-day responsibilities to manage the business. They also do not get involved with the management or executive tasks; otherwise, they would risk losing their title as a limited partner. Limited partners are purely investors, and they usually purchase shares in a family business in order to receive dividends or interest.
Advantages of a Family Limited Partnership
1. Tax savings in estate planning
The interest that an owner grows in the business can be transferred to other individuals with no taxes incurred. Doing so reduces the business owners’ estate size, which decreases their estate tax burden.
Typically, family members hope to transfer ownership interest to their children and can do so through an annual gift tax exclusion. Currently, the amount is $15,000 per individual. Therefore, engaging in a family limited partnership is a strategy for business owners to slowly shift the tax burden to their children while being able to avoid inheritance taxes.
2. Protection of assets
In a family limited partnership, the business’ assets can be kept in the control of the family since the assets are considered to be the property of the partnership. Therefore, if there are any outside investors who want to be involved with the business, they will not be able to.
If a limited partner also leaves the family, such as a divorce, he/she must also return the shares back to the business. Doing so keeps the ownership and control of the business within the family.
3. Transfer of family wealth to future generations
A family limited partnership is a way for families to preserve the family business for lineal descendants and transfer assets to their children. Usually, senior members of the family (i.e., parents) are general partners in the partnership. If their children are limited partners, their parents can eventually shift their shares of the business to their children, which allows their children to become general partners and gain full control of the business in the future.
Disadvantages of a Family Limited Partnership
1. Suitability with the nature of the business
Not all businesses are suitable to adopt an FLP structure. Family limited partnerships are effective in businesses that are associated with real estate or companies with a significant number of assets, so it is easier to pass on the wealth in estate planning. For businesses that own more intangible assets and focus more on providing services, such as teaching or consulting, they may not be suitable for a family limited partnership.
2. General partners face unlimited liability
If the business is liable for debt or bankruptcy, general partners are personally liable. It means that the general partners will be required to hand over personal assets to cover the business’ financial obligations. General partners are also liable for the actions of other general partners too.
On the other hand, limited partners do not face the same problem because they enjoy limited liability. They are protected from the need to give up personal assets to help the company pay for its debts.
3. High costs
Establishing a family limited partnership is involved with financial implications with contracts, estate planning, and tax matters. It is advisable for one to seek legal advice before establishing such a partnership.
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