A Family Limited Partnership is a sophisticated financial planning instrument which, when properly executed, allows families to hold and manage their wealth and family businesses for several generations. It has become more and more common for families with significant wealth to create a Family Limited Partnership instead of a corporation.
How is a Family Limited Partnership different from other business entities?
The major difference is in the tax consequences. The profits of a standard C corporation are taxed by the federal government at up to 35% and then taxed again when they are distributed to the shareholders at a rate of up to 39.6%. So, the combined corporate and personal tax rate of a standard C corporation can exceed 60%. This is before either state or local income taxes are taken into account.
An S corporation, however, is taxed only at the shareholder level. So, an S corporation is more appealing than a C corporation. Yet, there are many restrictions imposed on S corporations, including qualifying requirements and corporate functioning.
A partnership, on the contrary, is considered a “flow-through” company, meaning that the profit of the business entity is taxable to the individual owners and not the business. This is why a limited partnership has become a very popular, flexible and tax-efficient method for conducting business.
Why do families benefit from Family Limited Partnerships?
A Family Limited Partnership is better suited to achieving the particular objectives that generally apply to family-owned businesses. For instance, a Family Limited Partnership is an ideal mechanism for senior family members to retain control of operations. It also allows family members to easily develop a plan for succession and future management of the business enterprise and to transfer family wealth between generations with the lowest amount of estate and gift taxes.
Appropriate Use of the Family Limited Partnership
When considering a Family Limited Partnership, it is important this type of entity is being chosen to actually accomplish valid business or investment purposes. Courts will consider certain factors in determining whether the business entity is truly valid, including
- whether it is being used to conduct a family business;
- whether the family wealth is being pooled and managed in a coherent and structured manner;
- whether there is a succession plan for transferring management of the business from one generation to the next.
Take care in creating a Family Limited Partnership
There are some vital steps that must be taken in order to properly create a Family Limited Partnership. The value of all interests transferred and retained in the partnership must be carefully documented. These values must also be reasonable and in conformity with the basic principles of sound business valuation techniques. Although this type of business entity is for families, it is also crucial that the partnership be created with specific regard to the kind of agreement that unrelated parties, acting at arm’s length, would reach in a similar situation.
If you have questions or concerns regarding your Family Limited Partnership, or need help in creating one to manage your family business, give us a call.