Family Limited Partnerships and QSBS

What is a family limited partnership?

A family limited partnership, or “FLP”, is a legal entity established when two or more members of a family create a partnership. The partnership is set up as a holding company, and the holdings may include business interests, real estate, securities, and related assets. Investment is typically done through shares in the partnership. The senior generation creates an FLP to protect wealth for the benefit of younger generations.

There are two types of partners in a family limited partnership: general partners, and limited partners.

General partners (GPs) control the partnership and are responsible for management activities and investment decisions. General partners are liable for the entire FLP; the FLP is subject to claims by creditors of the general partners. General partners may include restrictions on the transfer of FLP interests. They also determine who will receive their GP interests in the future.

Limited partners (LPs) purchase shares of the FLP but do not have controlling interests. They are only liable for the amount of their investment, and profit in proportion to that investment. Limited partners must pay personal income tax on their FLP profits.

Family limited partnerships must look and behave like business partnerships. They must hold meetings, take minutes, and pay general partners a fee for the day-to-day work of managing the partnership. FLPs may also make distributions to limited partners to cover their personal income taxes.

When should you consider a family limited partnership?

A family with substantial assets needs ways to protect its wealth for future generations. Family limited partnerships can be an important part of estate planning. They can lower or even eliminate gift or estate taxes by including children as noncontrolling limited partners. How? Because any future returns of an FLP remain in the FLP upon the death of a general partner, and are NOT considered part of the GP’s estate.

Here’s an example. A parent sets up a Family Limited Partnership. The parent becomes the general partner (GP) and their four children are limited partners. The GP places a $500,000 real estate holding into the FLP, and the children each purchase $10,000 of shares in the partnership. When the parent passes away, the FLP is worth $1.1 million due to appreciation in value of the assets. However, only the initial investment the GP made – the $500,000 – is considered part of the parent’s estate. The increase in value belongs to the partners in the FLP and is not subject to estate tax.

Assets above federal exemption limits are generally subject to a 40% federal estate tax rate. The Tax Cuts and Jobs Act (TCJA) doubled the estate tax exemption to $11.18 million for singles and $22.36 million for married couples, but only for 2018 through 2025. Many states impose additional estate taxes.

For this reason, families with assets above the exemption threshold may want to consider using a family limited partnership to protect those assets for their heirs.

What are some things to avoid when setting up a family limited partnership?

There are a couple of important pitfalls to consider and avoid.

First, the tax exclusion may not apply to personal asset investments. This is why it’s important to include real estate and securities in partnership holdings, rather than cash.

Secondly, if Qualified Small Business Stock (QSBS) is transferred to the FLP by a partner, then they lose their status and tax benefits because the partnership didn’t acquire the shares at original issuance. It may make more sense to keep QSBS as individual holdings.

Family limited partnerships are powerful but incredibly complex entities, and you should always consult with your tax professional and qualified accountants before setting up an FLP.

This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.

About QSBS Expert

QSBS Expert was founded by a group of entrepreneurs, investors, accountants and lawyers who came together when trying to navigate a QSBS situation of their own. We quickly realized that the regulations left a lot of open questions and the publicly available information was confusing to sift through…so we thought that others may also benefit from having a “go to” resource for all things QSBS.