Should our family business form an FLP?

An FLP, short for family limited partnership, is a business entity known as a limited liability partnership formed by family members only. All limited liability partnerships, including FLPs, have two types of partners: (1) general partners who run the business and whose assets are exposed to business creditors, and (2) limited partners who have no say in how the business is run but whose personal assets are generally shielded from business creditors.

The general partners, even though they have control, can own as little as 1% of the business, while the limited partners can own as much as 99%. Consequently, by organizing their business as an FLP, family members can transfer ownership to other family members while retaining control, and/or generally protect the personal assets of those family members who become the limited partners. An FLP can be particularly attractive to seniors who want to keep control of the family business until the younger generation gains experience and becomes competent enough to manage the business on their own.

An FLP can offer other advantages as well:

• You can shift business income and any future appreciation of business assets to other family members (who may be in a lower tax bracket).
• You can minimize transfer taxes by transferring FLP interests in increments that are free from federal gift tax under the annual gift tax exclusion ($12,000 per transferee in 2006).
• Because limited partners have restricted rights, gifts of FLP interests to limited partners may qualify for discounts that reduce their taxable value for federal gift tax purposes by as much as 35%.

Note: Creating an FLP and taking discounts invites close scrutiny by the IRS.