Keeping the Family Business in the Family
When a family business passes from one generation to the next, estate taxes often inflict a crushing burden. One succession strategy that eliminates the problem is to give your children shares of the company while you're still alive using a family limited partnership (FLP).
With this estate planning tool, you not only keep the business in the family, you retain control and collect potentially huge breaks on gift and estate taxes. Here's a three-step guide:
Get a professional valuation of the assets to be transferred to the partnership. The IRS sometimes challenges these transactions and its main argument is the value put on the assets at the time they were transferred to the partnership. We can assist you in obtaining a proper business appraisal.
Create an FLP and transfer your business, rental real estate or other valuable assets to it in exchange for the ownership interest in the partnership. Start by being both the general partner and the initial limited partner. Legal title of the assets must be changed to reflect the transfer.
Make gifts of all or most of the limited partnership interests to your children or other heirs. You retain the general partnership interest, which is usually 1% of the total value. By doing this, you retain control over the business or property. Under partnership law, limited partners have little or no say in how assets are managed. As the general partner, you can draw a salary. Yet you aren't considered the owner so only the value of the partnership interests you still own when you die will be included in your estate.
But here's the main advantage of an FLP: When you make gifts to your children, you can often claim valuation discounts of 20 to 40 percent. In effect, you're saying that each piece of the family business that you give away via a limited partnership interest is worth less because the recipient has limited power and liquidity.
By using the valuation discounts and the annual gift tax exclusion, an FLP can become the foundation of a family gifting program. You are allowed to give $11,000 a year ($22,000 for married couples) to as many recipients as you want without any gift tax consequences. With a series of gifts, you can transfer all or most of your company out of your taxable estate.
Warning: For a family limited partnership to pass muster with the IRS, there must be a business purpose. And remember that IRS auditors crack down on valuations they consider too aggressive. Our attorneys are available to consult with you to see whether this estate planning tool meets your needs.