As Trump era estate tax cuts are likely coming to an end in 2025, wealthy business owners are increasingly utilizing Family Limited Partnerships (FLPs) to significantly save the family taxes when they are gone.
Understanding Family Limited Partnerships
An FLP is a business holding company owned by two or more family members. Family members buy shares of the business and profit in proportion to the number of shares they own, which is outlined in the operating agreement.
Types of Partners in FLPs
Family Limited Partnerships consist of two distinct partner roles: General partners and Limited partners. General partners typically hold the majority share and handle daily management tasks and investment transactions. They may also receive a management fee from profits as outlined in the operating agreement. On the other hand, Limited partners have no management duties. They earn dividends, interest, and profits based on their ownership shares in the FLP.
Leveraging FLPs for Estate Tax Exemptions
Wealthy business owners can leverage the current estate tax exemption, set at $13.61 million per individual or $27.22 million per married couple in 2024, by utilizing Family Limited Partnerships (FLPs) to transfer assets at significant discounts. For instance, one or both parents may consolidate their business assets, which could encompass real estate and stocks. As the general partner(s), the parent(s) can then designate their children as limited partners and gift them interests in the partnership. Consequently, the children will receive distributions from the generated revenue, albeit without control over the FLP assets. This arrangement allows parents to retain control while ensuring their children benefit from the partnership.
Estate Planning and Asset Transfer
The goal in estate planning is to transfer ownership of the assets to the children before the value increases. Therefore, the assets are transferred out of the parent’s estate and can continue to grow. Additionally, the business owner can claim a discount on the assets within the FLP and utilize less of the estate tax exemption. Examples of discounts claimed are typically between 10% and 45% for cash for business purposes or illiquid assets. However, the higher the discount, the more likelihood of an IRS audit. Limited partners receive discounts because they have no control over the assets or business operations.
Implications of Estate Tax Law Changes
It is estimated that the estate tax will be cut approximately in half when the current law sunsets at the end of 2025 unless Congress affirmatively acts. Today, if a couple transfers assets outright to their children which total over $27.22 million, any assets over that amount will be taxed at 40%. If they wait until they die for their children to inherit their assets, along with the likely decline of the estate tax exemption, their equity may have significantly increased causing a much higher estate tax liability. By gifting equity before the end of 2025 into an FLP, along with utilizing the privately held company’s valuation discount, gift and estate tax could be significantly reduced. If the couple waits until after 2025 to gift the equity and the sunset occurs, they will only be able to gift approximately $14 million compared to the $27.22 today.
Legal Protections and Considerations
FLPs also offer some legal protections to limited partners from creditors and divorcing spouses. While protections vary by state, usually the equity is not reachable. Creditors may also end up with a big tax bill because income distributions are not required but the income is still taxed and so the creditor may end up with a tax bill and no way to pay it.
Cautions in FLP Setup
When setting up an FLP, partners must be cautious. Parents should wait many months after setting up the entity to gift shares to their children. If they gift immediately, the IRS might claim the FLP was only formed for the purpose of utilizing the valuation discount. Due to the need to delay the transfer of shares to children, families should not wait to set up FLPs as 2025 closes in. It’s time now to take advantage of Family Limited Partnerships for a significant tax savings for families.
For assistance setting up an FLP, or to discuss further, please contact KJK Estate, Wealth & Succession attorney Susan Friedman (SLF@kjk.com; 217.736.7272).