Fedele and Murray, P.C.

17 Walpole Street, Norwood, MA 02062-3318 - (781) 551-5900

Family Limited Partnerships

A family limited partnership can be an effective tool to both help reduce estate taxes and to protect assets from the claims of creditors. A limited partnership is comprised of one or more general partners who manage the partnership business together with one or more limited partners who share in the profits and losses but take no part in running the business. The limited partners contribute the capital, either money or other assets, as their investment in the partnership. For example, a parent might contribute assets to such a partnership. The parent  would serve as general partner, and would also be a limited partner. Limited partnership interests could then be given away to the children.

From an estate tax perspective, gifting limited partnership interests can be a very useful tool. Several things can happen. First, when you gift a limited partnership interest, you can generally “discount” the value of what you are giving away. Assume a limited partnership has $1,000,000 worth of assets. If the individual creating the partnership were to give away a 1% interest, that equates mathematically to $10,000. For gift tax purposes you could actually discount the value of that interest by as much as 30% (sometimes more or less, depending upon the nature of the partnership and the assets, and a number of other factors). Thus, the gift might be only $7,000 for gift tax purposes. In other words, if one wanted to keep one's gifts within the $15,000 annual gift tax exclusion, using a 30% discount one could actually give away $20,000 of the partnership (or a 2% interest). Ultimately upon the death of the individual creating the partnership, his estate would be taxed on the percentage interest still owned in the partnership. Again, however, the value of that interest could be discounted because the individual does not own the entire interest. “Minority” discounts are available when one owns less than a majority interest in an entity. Discounts are also available for “lack of marketability,” the ability to freely sell the limited partnership. Restrictions can be placed on the transfer of limited partnership interests making the interest very unappealing to those outside one's family.

For a married couple, if they placed 49% of the partnership into each of their names and gave away the remaining 2%, the value of each spouse's interest will be less than the $490,000 you would otherwise presume (assuming a $1,000,000 total value). Again, because each interest is a minority interest (and would have no right to manage the partnership) the value might be as little as $343,000, assuming a 30% discount. Thus, a couple will have effectively caused about $314,000 of value to "disappear" for tax purposes by simply dividing the partnership interests into a minority for each spouse.

The family limited partnership can also be used for certain income tax planning. For example, if the parent remains a general partner he could pay himself a salary that will be taxed at whatever income rate he is in. A portion of the income earned by the partnership, if any is left after the general partner's salary is paid, can then be distributed to the limited partners. If the children have little income of their own, the money they receive from the partnership may be taxed at a lower income tax bracket, thus benefiting the family as a whole. Generally, the income and/or losses from the partnership flow out to the partners on a pro rata basis and each partner individually pays a tax on that income. Note that this is the case even if no actual distributions are made to the partners; in such event they will still pay a tax on that “phantom” income.

For creditor protection purposes, a creditor who sues a limited partner and recovers a judgment against that limited partner can generally only obtain a “charging order” against the limited partner’s interest. What this means is that the creditor will be paid only from whatever distributions are made from the partnership. If the general partner makes no distributions to the limited partner, the creditor might never be paid. The creditor has no vote or participation in the management of the partnership business, and might not even be entitled to inspect the partnership books.

A drawback to the limited partnership is the fact that it is a separate entity for tax purposes. This means that partnership income tax returns need to be filed each year. Also, the partnership must file annual reports with the Secretary of State’s office. Generally, the extra administrative work required is not an undue burden, but it is something that must be considered.

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