family limited partnership

Family Limited Partnership Vs Trust: How Do I Choose?

Family Limited Partnership Vs Trust: Which is Better for Your Assets?

Estate planning is a complicated process when you have a family business. Your heirs aren’t ready to take over the reins just yet, but you need to prepare them for the complex roles you perform every day. Fortunately, you have options when it comes to passing on your family investments. Let’s look at two of the most popular: family limited partnerships (FLP) and trusts.

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What Is a Family Limited Partnership?

Family Limited Partnerships (FLPs) are a specific type of limited partnership used for estate planning and asset protection within families. The parents usually create the partnership as part of the estate planning process. 

By transferring assets into the partnership, parents can gradually gift or transfer ownership to their children or other family members, reducing the size of their taxable estate upon death.

Here are some key characteristics and benefits of a family limited partnership:

  • Ownership Structure: In an FLP, family members pool their assets into the partnership and become either limited partners or general partners. The general partners manage the partnership and control its operations and decisions.
  • Limited Liability: Limited partners’ personal assets, meaning their personal assets are protected from the partnership’s creditors, debts, or legal liabilities. General partners, however, have unlimited liability for the partnership’s obligations.
  • Tax Advantages: FLPs can offer tax advantages such as tax minimization through gift tax valuation discounts (due to restrictions on marketability and lack of control over limited partnership interests).
  • Asset Protection: Assets held within an FLP may receive some protection from creditors (as long as the partnership is structured and operated properly). This can be a useful feature for safeguarding family wealth.
  • Centralized Control: FLPs allow for centralized management of family assets, making it easier to coordinate investments, business operations, and succession planning among family members.
  • Succession Planning: If the FLP holds a family business, it can ensure continuity and provide a structured way to transfer ownership and management to the next generation.

When Are Limited Partnerships Generally Used?

Limited partnerships are typically used when capital investment and operational management need to be separated. Limited partners can participate in ventures without assuming full operational responsibility or liability. Family limited partnerships are primarily used for managing and protecting family assets and business interests. 

Here are common scenarios where limited partnerships are utilized:

  • Real Estate: LPs are commonly used in real estate investments where limited partners contribute capital for property acquisition, development, or management. The general partner handles day-to-day operations and decision-making.
  • Entrepreneurial Ventures: There are advantages of LLPs in entrepreneurial ventures. One or more partners might want to invest capital, but not actively participate in management. The general partner(s) handle operations while limited partners provide financial backing.
  • Industry-Specific Investments: LPs are used in various industries where specialized knowledge or experience is required from the general partner(s) to manage operations effectively. Limited partners benefit from potential returns without direct involvement in management.
  • Professional Partnerships: In some professions, such as law or accounting, LPs can be formed where partners contribute capital but don’t actively manage the firm’s operations, leaving that to the general partner(s).

How Do Family Limited Partnership Distributions Work?

Distributions work differently for general partners and limited partners due to their respective roles and rights within the partnership:

General Partners

General partners may receive compensation for the services rendered to the partnership, which can be structured as management fees or salaries. They might also receive distributions of profits or income generated by the partnership based on the partnership agreement.

Limited Partners

Limited partners are entitled to receive profits or income distributions from the partnership according to their ownership percentage or as defined in the partnership agreement. Distributions to limited partners are usually made on a pro-rata basis based on their ownership interests in the partnership.

Process of Distributions

Setting up and managing distributions in an FLP requires careful consideration of legal, tax, and financial implications. It’s important for partners to work closely with financial legal advisors who have comprehensive knowledge of partnership structures and estate planning.

  • Profit Allocation: The partnership agreement outlines how profits and losses are allocated among partners. This can be based on seniority, ownership percentages, or other criteria agreed upon by the partners.
  • Timing: Distributions can be made periodically (e.g., quarterly, annually) or as specified in the partnership agreement.
  • Cash vs. Non-Cash Distributions: Distributions can consist of property, cash payments, or other assets owned by the partnership. Distributions are subject to the terms of the agreement and tax implications.
  • Tax Considerations: Profits and losses from an FLP are typically treated as pass-through income (reported on the partners’ personal tax returns), regardless of whether they receive cash distributions.

Differences Between Family Limited Partnerships and Trusts

If structured correctly, trusts and partnerships both offer wealth preservation and asset protection for the next generation. However, there are differences in the ways each one accomplishes its goals.

Asset Management and Control

Trust: Trusts are used to manage and distribute assets according to specific instructions and conditions set forth by the grantor (person establishing the trust). The trustee (appointed by the grantor) manages the trust assets and distributes income or principal to beneficiaries (who may include family members or charities).

Partnership: In an FLP, general partners (often parents initially) maintain control over the partnership assets and operations, while limited partners (typically children or other family members) have limited control but benefit from potential income and tax advantages.

Estate Planning

Trust: Trusts allow for the efficient transfer of wealth and assets to beneficiaries while bypassing probate, which can provide privacy and potentially reduce estate taxes. Grantors can specify conditions under which assets are distributed (e.g., reaching a certain age or achieving specific milestones), giving them full control over inheritances.

Partnership: FLPs facilitate the gradual transfer of assets to the next generation through gifts of limited partnership interests. Due to loss of marketability and lack of control, the value of limited partnership interests may be discounted for gift tax purposes, which can be advantageous when transferring wealth to family members.

Creditor Protection

Trust: Certain kinds of trusts, such as irrevocable trusts, can offer protection from creditors, as assets are considered separate from the grantor’s estate.

Partnership: Assets held within an FLP may have some protection from creditors, depending on how the partnership is structured and operated. The partnership agreement could also restrict the transferability of partnership interests, affecting the liquidity of limited partners’ investments.

Flexibility

Trust: Trusts come in various forms (revocable, irrevocable, living, testamentary, etc.), and each type offers flexibility in asset management, distribution timing, and tax planning.

Partnership: An FLP’s flexibility lies in management and decision-making. It allows active management by general partners while involving family members as limited partners.

Choosing Between a Family Limited Partnership or a Trust

Deciding between a family limited partnership and a trust depends largely on your overall goals, family dynamics, and preferences regarding asset management.

For example, an FLP may be suitable if:

  • You want to retain control over assets while involving family members in management.
  • You want to benefit from potential tax advantages.
  • You have significant business or investment assets that can be structured within the partnership.

On the other hand, a trust may be suitable if:

  • You prefer to manage asset distribution yourself.
  • You want to protect beneficiaries (including yourself) from mismanagement or incapacity.
  • You seek to minimize estate taxes, avoid probate, and maintain privacy in asset distribution.
  • You want to set specific conditions or timelines for asset distribution to beneficiaries.

You might be thinking – Hey, Wait! I should combine these two strategies and double the benefits! Well, that would not be as smooth or beneficial as you might think. Both FLPs and irrevocable trusts have their place, but when combined, there are complex tax issues that could have BAD results.

Protect Yourself with the Right Legal Ownership StructureAt Yolofsky Law, we assess your specific situation and personal goals to recommend the most appropriate structure—an FLP, a trust, or a combination of both—to effectively achieve your objectives. Email us at [email protected] today or schedule a 15-minute call to get the answers you’ve been looking for.