A family limited partnership is generally financed with specific assets. Real estate provides the ideal investment, but not all assets are suitable for transfer to society. With respect to corporate partners, the shares of the S corporation cannot be owned by a partnership. The partners do not recognize gains or losses when they contribute property to the partnership in exchange for their partnership interests. Additional capital contributions do not generate a loss or profit for the partners or the partnership.
When a partner contributes capital or assets to the partnership, the partner receives an interest in the partnership based on the partner’s contribution as a percentage of all contributions. Any additional contributions will increase the partner’s share and all other shares must be adjusted accordingly.
Donation of association units
The easy division of the society’s interests into units offers the possibility of transferring assets to family members within the available annual exclusion of gift tax which is $ 14,000 per year per donee for 2014-2015 or the equivalent The unified credit exemption is $ 5,340,000 in 2014 and $ 5,430,000 in 2015. There are valuation discounts that can be used to reduce the value of the partnership units by 20 to 40 percent for gift tax purposes.
Three types of valuation techniques are generally used to calculate the fair market value of an interest in a closed entity. The market method (also known as the comparable sales method) compares the closed company with unknown share value to similar companies with known share value.
The income method (or discounted cash flow) discounts the anticipated future income of the company whose shares are being valued to present value. The net asset value (or balance sheet) method is generally based on the value of the company’s assets net of its liabilities.
The market method or income method is most often used when the closed company conducts an active trade or business. Net asset value is most often used when a closed business primarily has real estate or investment assets and is not conducting business or business.
The value of a gift to a donee is the gift’s fair market value when it is made, not the fair market value that it once was or may one day be. In income resolution 93-12, the IRS agrees that a minority interest in a limited partnership with restricted property rights for the limited partner qualifies for a discount from the fair market value of the underlying assets. This allows parents to give considerably more to their children within the gift tax exclusions and without loss of control.
To be eligible for the discount, the limited partner’s interest must be considered a minority interest (discount for lack of control) and / or not freely transferable (discount for lack of marketability). IRC §2036 (b) includes gifts in the taxable estate of the donor of corporate shares in a controlled corporation in which the donor retained the right to vote the shares. There is no corresponding tax code section for the interests of the company.
Donors may want to structure transfers, or gifts, of limited partnership units to qualify for the current unified credit waiver equivalent as noted above. These transfers do not have to meet the criteria as gifts with present interest, but disposition of the estate at the time of death is generally desired. Even if the donor continues to serve as the partnership’s general partner and acts in a trustee capacity for all partners, the gifted partnership units will not be included in the deceased donor / general partner’s estate.
Operation of a limited family partnership
As general partners, parents can accept a fair salary from society for their leadership skills. They can also establish whether the partnership will preserve or allocate income to its partners or whether they can lend funds to a limited partner. Parents can get money from the partnership to support their existing or retirement needs, subject to fiduciary standards (which are lower than those of a trustee). Wages paid to anyone in the partnership are subject to withholding as dictated by the IRS and the state in which the partnership operates.
A corporation is required to file tax returns annually. The federal return is Form 1065 and the state has an equivalent form. Any income received by the partners must be included in their corresponding tax return. Even if no distribution occurs, partners must claim the amounts reported on the K1 form provided by the association.
Taxes and insurance for a family limited partnership
When considering income taxes, all assets transferred from the partnership to the partners retain the same nature as with the partnership. IRS Income Resolution 83-147 explains the wealth taxes on life insurance owned by a partnership with one of its partners. The result should be the same as for business-owned life insurance. If the partnership is the beneficiary of the life insurance, then the insurance death benefit will be included in the partner’s estate only indirectly because of the change in the value of the deceased partner’s equity interest.
To avoid increasing the deceased partner’s partnership interest in a portion of the life insurance proceeds, the policy could include adult children as policy owners and beneficiaries at the beginning of the policy’s existence. General partners can distribute income to children as limited partners to pay the premiums for the policy owned by the children or the grantor of a trust created by the children. Grantors could direct the beneficiary’s estate in the event the grantor dies before the father, which could help protect the cash value of the policy in the event of a divorce.
The risks of the family limited partnership
The IRS has issued, without administrative hearings, new regulations under IRC Subchapter K. In short, the IRS will rule out a partnership as an entity if the partnership’s primary function was to avoid income tax, either at startup or during operation. The proposed regulations are specific to income tax and do not apply to gift and inheritance tax assessments. This does not mean that the IRS will not deal with estate and gift appraisals in the future. There are costs involved in training and maintaining an FLP, including:
• Attorney fees to form the partnership (however, an attorney is not required
• Appraisal fees for underlying assets and “portions” of society that are gifted to family members of the younger generation;
• Accounting fees for the K-1 partnership and other financial assets;
Transfer tax costs, such as documentary stamps when transferring real estate. But for many investors, the benefits of well-planned FLPs easily outweigh the risks and costs.