Family Limited Partnership: Disadvantages

Disadvantages, General Partners, Limited Partners,
Family Succession Planning, Tax-Free Wealth Transfer

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Family Limited Partnerships can be abusive tax-free wealth transfers. How does the family limited partnership work and what are the disadvantages? To discount estate tax valuations of underlying assets used as a tax deferral strategy when gifting to the younger generation.

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Family limited partnerships, one such traditional limited partnership, have been over marketed as wealth transfer devises. Family limited partnerships are red flags for the Internal Revenue Service as abusive tax-free wealth transfers. Family partnerships have been widely propagated as the devise of choice for transferring the family business and other highly appreciated assets tax-free from parents to their children.
Different programs are available to transfer ownership and the management of a family business. The Family limited partnership is nothing more than the traditional partnership for which “only family members” can be partners as either general partners or limited partners.

Did you know that general partners of family partnerships are exposed to frivolous lawsuits, court judgments, and creditor seizures? The problem is avoided if an irrevocable trust such as the Ultra Trust® (not a revocable trust) is used as the general partner of your family limited partnership.

How does the Family Limited Partnership Work?

The older generation (i.e. parents) become owners with 2% stake in the business and thereby establish themselves as general partners in a family limited partnership. Over a period of time, by gifting limited partnership interests, the younger generation (i.e. children) end up as limited partners with a 98% stake in the business. This all sounds wonderful and an almost ideal tax deferral strategy. But is there a catch to all of this great tax-free wealth transfer and strategy?

Gifting to the Younger Generation with a Family Limited Partnership

The result is highly appreciated assets are transferred from the estate of the parents to the children presumably tax-free. When carefully and properly implemented the family limited partnership is a useful tool. But there are better ways to achieve a significantly more efficient transfer of wealth.
Did you know the IRS considers these family limited partnership arrangements abusive when overzealous practitioners over claim two commonly used discounts in the valuation of underlying (highly appreciated) assets in estate tax valuations? The IRS comes down significantly hard, when these arrangements are made over a deathbed especially in the hours or days before death. Please note that there’s an increasing congressional opposition to the use of family limited partnerships.

Two Discount Estate Tax Valuations of Underlying Assets in Family Partnerships are:

  1. Lack of marketability discounting which is typically 15% to 35% reduced estate tax valuation due to a limited market for the business or the assets, if sold.
  2. Limited minority interest discounting which is typically an additional 15% to 35% reduced estate tax valuation to the minority position (lack of control) in the business or underlying assets.
Combined, these two discounts can amount up to 70% or more. But how much is too much?

Disadvantages of Family Limited Partnerships:

  1. Gifted property does NOT receive the “stepped-up” basis treatment that bequeathed property receives. Therefore the children, who have received “gifted partnership interests” may face unexpected capital gains tax liability. If discounting is reasonably and carefully applied, it’s a significant tax saving devise. Keeping in mind that it’s great for the parents, not so good for the children because of the unexpected capital gains tax liability that can be imposed on the children.
  2. General partners are not insulated from potential lawsuits, judgments, or creditor seizures. This problem can be avoided if the general partner is the Ultra Trust. The parents as general partners are 100% in control of the assets and 100% responsible for a potential lawsuit. General partners will have no asset protection in these cases.

Family Business Succession Estate Planning:

If you have an interest in family business succession planning, there are several financially-engineered devises addressing the following important issues:
  • Ownership of family business – Which of the family members will become the future owners of the business? What method or combination of methods is the most effective in consideration of asset protection and wealth preservation, elimination of probate, deferral of capital gains taxes, elimination of estate taxes, and reduction of taxes on earned income or possibly eliminate income taxes.
  • Control of your family business – Which of the family members will become the future managers. Not all family members have management skills. Some family members should have voting control, while others must become silent partners.
  • Dispute resolution – How will family members deal with potential disputes? What mechanism is fair to controlling and non-controlling family members?
  • Employment – Which family members will be employed by the business?
Read more traditional limited partnerships, your financial goals, estate plannning, deferring taxes, deferring income tax, deferring capital gains tax by clicking here:

Category: Financial Planning, Wealth Management

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