In the right circumstances, a Family Limited Partnership offers an attractive vehicle for gifting. In contrast to outright gifts and transfers in trust, it offers more control and more flexibility, as well as an opportunity to discount the value of the gift. Most business and investment assets are eligible to be transferred into the partnership.
Procedure
· Client creates a partnership under state law. It allocates profits and losses among the partners.
· Assets are transferred to the partnership in exchange for partnership interests. The transfer of assets is not an income taxable event. Upon subsequent sale, the appreciation which occurred prior to transfer is allocated to the client, and appreciation subsequent to the transfer is allocated to the partners in accordance with their interests in the partnership.
· A portion of the contribution is allocated to a general partnership interest which is held by a corporation or limited liability company (LLC) to limit individual liability and avoid termination of the partnership on the death of an individual general partner. Usually, the general partner would be owned by the client.
· Limited partnership interests are gifted to family members. A gift tax return would need to be filed when gifts are made.
· If income is distributed, it generally must be allocated among partners in proportion to their capital accounts.
· A partnership is a pass-through entity for income tax purposes. A partnership return (Form 1065) is required and each partner must report his/her share of partnership income or loss.
· The partnership will dissolve upon the expiration of the partnership term stated in the agreement, upon the death or withdrawal of all general partners, or upon the agreement of all partners to terminate, whichever occurs first. Upon termination, partnership assets will be allocated among partners according to their proportionate partnership ownership.
Advantages
· Control of Investments – The client, as owner of the general partner, retains control over the investment of gifted assets, while affording other family members the opportunity to participate.
· Control of Distributions – The general partner has the sole right to determine whether the partnership will retain income or distribute income to its partners.
· Protection from Creditors – Creditors of the limited partners cannot seize partnership interests, dissolve the partnership, or sell off the assets of the partnership to satisfy their debts.
· Divorce – Most jurisdictions will not award separate property to a divorced spouse. The partnership provides a convenient means of segregating separate property and restricting who may become an owner of or interest in the partnership.
· Flexibility in Gifting – The clients direct the nature and extent of transfers of their limited partnership interests to family members.
· No Need to Divide Assets – If may be impractical to divide a piece of property or family business among many family members. Instead, assets such as these may be transferred to a limited partnership, and partnership interests gifted to family members.
· Discounts – Gift taxes on gifts of partnership interests are reduced because of minority and nonmarketability discounts.
· Probate – Placing out-of-state assets in the family limited partnership can save legal costs associated with out-of-state probate.
· Amendable – If all partners agree, the partnership agreement may be amended to reflect new conditions.
· Private Dispute Resolution – The partnership agreement can provide for private mediation to resolve family disputes.
Disadvantages
· A qualified business appraiser must be hired to determine the fair market value of partnership interests which are transferred to bring into account appropriate nonmarketability and minority discounts.
· Partnership must file annual federal and state income tax returns.
· Partnership income must be reported on the partners’ tax returns whether or not actually distributed.
· Donees receive a carry-over basis in the partnership interests they receive which would be based upon the clients’ basis in the property contributed to the partnership.
· If 80% of the value of the partnership assets consist of readily marketable securities, and two or more people transfer non-identical assets to the partnership, the partnership will be treated as an “investment company,” and the client will recognize gain or loss on property contributed to the partnership.
Consequences
The following is an illustration of the consequences of establishing a family limited partnership.
Assumptions:
· Initial value of assets which may be transferred to the partnership is $3,000,000.
· Assets grow at 7% per year.
· Discount of 33% used for gift tax purposes.
· Client and spouse have not used any of their combined Gift Tax exemption.
· Client and spouse have other assets which will use their remaining Federal Estate Tax exemption.
· Client and spouse live ten years from the time the assets are transferred.
· Use exemption amounts and tax rates in effect for 2008.
Assets transferred to limited partnership:
Value of assets when transferred $3,000,000
Less Discount (33%) 1,000,000
Value of assets for transfer tax purposes $2,000,000
Gift Tax exemption 2,000,000
Taxable transfer $ -0-
Gift tax due on current transfer (45%) $ -0-
Assets not transferred to limited partnership:
Value of property after 10 years $5,901,454
Value of assets for transfer tax purposes 5,901,454
Unused Federal Estate Tax exemption (2,000,000)
Taxable transfer at death $3,901,454
Estate tax due on assets at death (45%) $1,794.669
Transfer tax savings $1,794,669
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