Family Limited Parternships         

If you have a family business that you would like to pass on to your children, it may be time to consider the formation of a family limited partnership (FLP).  An FLP is an entity that is set up not only to help conduct a family business, but also to pass that business on to the next generation with a potentially substantial savings in estate or gift taxes.


FLPs are used for many purposes and in many different ways, but probably the most common use would be the following example:

FLPs are used for many purposes and in many different ways...


John and Kathy own a widget manufacturing company that they have spent years nurturing and growing and they now wish to see that it passes on to their children at their death.  After examining their various options, they decide to transfer the business into an FLP.  At the time of the transfer, they also grant their children the majority ownership of the FLP, but maintain control of the company by making themselves the general partners responsible for all decision making.

The FLP Advantage

Now, ordinarily a transaction of this type will simply trigger gift taxes to the parents on the full value of the company when it is transferred to the children.  However, with an FLP set up in the manner above, the children's ownership interest will be "discounted" because they are limited partners with no vote in the governance of the company.  

It is similar in principle to preferred corporate stock being worth less than common stock in most instances because the preferred stock has no voting rights.

Since the children's new ownership of the FLP (and the underlying family business) is deemed to be worth less than a "voting interest" ownership, the transfer will be subject to lower taxes than an ordinary ownership transfer would have been.  

John and Kathy of course, have managed to transfer most of the company to their children, but at the same time, get to continue running their business as they see fit without concerns about interference from their meddlesome children.

Too Good To Be True?

If the above scenario sounds a little "convoluted" to you, you're not alone.  The IRS thinks so as well and has challenged FLPs in court stating that they lack economic substance among other arguments.  

However, after some IRS setbacks in U.S. Tax Court whereby the judges lowered the discount taken, but did not throw out the FLP, it is anticipated that FLP usage will continue to grow at a fast pace.

Many estate planners now are even setting up FLPs simply to hold family investments as opposed to conducting a family business.  In 2000, the Clinton administration asked for legislation barring discounts for non-business interests in FLPs and FLLCs (family limited liability companies - a similar type entity), but Congress has not addressed the issue.

The IRS Strikes Back?

The IRS, despite the court setbacks, has not given up the fight on this issue and we strongly urge you to speak with us before venturing into this potential minefield.  You can expect the IRS to continue challenging both the use of FLPs and the discounts being taken on them.  

In a recent IRS legal paper, the agency argued that the FLP should be ignored where formed just to hold and transfer family wealth.  It argued once more that a family entity created to get estate tax or gift tax valuation discounts lacks business purpose and economic substance.  We can expect more court challenges in the near future...