In General, the FLP may have several non tax features and reasons for its existence, but also has the potential of substantially reducing the estate and gift taxes of the transferor. The FLP will mainly consist of family members including either adult or minor children or both. In most cases a minor child will not be deemed to possess the maturity and experience to hold legitimate title to the limited partner interest. In this regard, there are three practical solutions: (1) Title can be held under the California Uniform Transfer to Minors Act found in Probate Code Sections 3900 through 3925; (2) A Children's Trust can be established to serve as the limited partner; or, (3) A Guardianship can be established.
Custodianships are relatively inexpensive to set up whereas the Children's Trust is more expensive and the Guardianship can very costly and cumbersome. All types of assets can be owned by an FLP, but assets which are inherently dangerous and have high liability risks should not be owned by an FLP that owns other assets. These high risk assets should be placed in a separate corporate entity or limited liability company to limit liability or they should be contributed as the only asset to a Family Limited Partnership of which an LLC or corporation is the general partner. Moreover, assets which are necessary for the living expenses of the transferor should not be contributed to the FLP.
One of the most significant disadvantages of the FLP is there will be no step up in basis for the assets in the partnership at the death of the general partner. If the assets have a low cost basis the transferor is giving up the potential step up in basis at his or her death. Accordingly, a sophisticated review needs to be made analyzing and weighing the benefits of having the discounted property value available to reduce estate taxes as compared to the savings in income taxes resulting from the step up in basis.
Most Family Limited Partnerships are set up and designed to hold real property. The typical situation involves a senior family member transferring property to the Partnership in exchange for a small general partner interest and a very large limited partnership interest. The general partner interest allows the transferors to have complete control over the day-to-day investment and management decisions relating to the partnership property. The limited partners do not have any voice in the management of the partnership.
Most FLPs are also structured so as to provide that the limited partners will not be allowed to transfer their partnership interest during their lifetime without the consent of the other partners. This restriction on the transfer of the limited partner interests along with other factors provides for the discount of the value of the gifted partner interest for gift tax purposes by reducing its marketability ("Marketability Discount").
Because the limited partners will not have any voice in the management of the partnership, the value of the gifted limited partner interest will be discounted to reflect this lack of control ("Control Discount"). Combining these two discounts is sometimes referred to jointly as a minority discount and typically reduce the value of the transfer gift for gift tax purposes by 20% to 50% (and the taxes by 10% to 25% or more) depending on what type of assets are held by the partnership (a greater discount is typically allowed when the assets held by the partnership are not readily marketable). The senior family members retain control over the partnership property for as long as they desire.
The Partnership Agreement can be drafted to make the senior family members the managing general partners with sole management control over the partnership. The children can have as much or little control as desired. After the Family Limited Partnership has been established, it can be used as part of the transferor's estate plan to make discounted lifetime gifts to the children. Alternatively, the interest in the FLP can be held until the first of the transferor's death after which time the surviving spouse can then begin making gifts of the limited partner interest to the children.
The second use of the FLP has the double benefit of allowing the survivor's full step up of basis of the underlining partnership assets for income tax purposes after the first death and following the survivor's death the limited partner interest can still be discounted for estate tax purposes. The Minority Discount of the value of the Limited Partnership interest allows the transferor to effectively make large annual tax free gifts. In the case of real estate, the due on Sale Clause or Acceleration Clause of the underlining promissory note and deed of trust which secures the real estate to be transferred should be reviewed.
Stock accounts held in "Street Name" by securities companies can be transferred by an assignment document between the transferor and the FLP and the proper execution of the internal documents of the securities company. It is normally a good practice to make sure that any brokerage accounts transferred into the FLP are free of margin loans because a margin call can result from the transfer into the FLP.
Many closely held corporation stocks contain restrictions on transferability. Assuming that the stock can be transferred into the FLP, the old Share Certificate should be delivered to the Corporate Secretary or Stock Transfer Agent for cancellation and a new Certificate issued in the name of the FLP.
Cash can be transferred directly into the Limited Partnership bank account. The transferor should check with their financial institution to make sure that if CD's are transferred, there are no penalties or loss of interest.
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