Your business has been your life.
Your family has been involved in various ways throughout the years and your business has become the center of your family. Whether your kids are still actively involved or not, you know you want to keep your business in the family. But how can you ensure that when you or your family pass, the business doesn’t leave the family?
Keeping a Business in the Family: Thinking About Future Generations
Joe’s business was built from the ground-up. Thanks to his business smarts and his family’s hard work, it had become quite successful.
All his children had worked in the business over the years, but his oldest daughter, Georgia, had been the driving force behind the growth of the business over the last 5 years. Her energy and talent had set-up a nice trajectory for growth that was quickly steepening.
Joe was getting older, and he could see the writing on the wall for his business. “I’m so happy with Georgia’s performance,” Joe began, “In every way she’s exceeded my expectations.” The only problem: she made the company so valuable she’d never be able to buy it.
Joe was concerned that his family, including Georgia’s children, wouldn’t be able to keep the business once they were no longer around. He knew the business could be a real asset to his employees, community, and his family. His concerned eyes met ours as he asked, “Is there a way to keep it in the family after Georgia and I are both gone?”
Our answer to Joe: yes!
Protecting an Asset with a Family Limited Partnership
Joe’s hard working daughter had built a valuable, income-generating asset. After all the work that had gone into the business, Joe wanted future generations to see the benefit from it. He knew the business would be a difficult asset to divide amongst his children and grandchildren, but Joe had the business sense to manage complex financial instruments. In this case, his financial instrument would be a family limited partnership (FLP).
The Basics of a Family Limited Partnership for Asset Protection
Family limited partnerships are not for every person, family, or asset. There are both advantages and disadvantages to using a family limited partnership for asset protection. As with all financial decisions, please consult professional advisors about your goals and situation. Let’s look into family limited partnerships.
What is a Family Limited Partnership?
A Family Limited Partnership (an FLP) is formed by a member of a family to form limited partnerships to help protect and control assets. An FLP enables parents to pass a business made up of one or several assets to the next generation outside of their estates. An FLP also enables their children to continue to pass on the business to their children. In Joe’s case, his asset was the business he and his family had built.
Why a family limited partnership?
In Joe’s situation, an FLP was the best way for him to shift the ownership of a business and benefit on the tax front. Transferring ownership of the asset is systematic with an FLP, allowing for transferring over time. This meant that Georgia didn’t have to buy him out all at once, but rather could receive transfer of partnership interests over time.
Additionally, because of the partnership structure, it would be difficult for creditors to get to the members of the partnership. It is important to note that the assets of the general partner would be 100% vulnerable while the limited partners have no exposure (other than their initial investment).
And if Joe set up his family limited partnership as general partners, he could retain as little as one percent of the partnership shares and retain control of the asset. Conversely, heirs can own as much as 99% and have no control at all.
Tax Benefits: Estate Tax and Income Tax Savings with an FLP
One of the largest benefits of a family limited partnership is the income and estate tax savings.
Joe’s business was worth more than $5 million. As much as the IRS would like “its share” when both assets change hands, it recognizes that a non-controlling share of an asset (in this case a business) isn’t worth an equivalent amount of cash. If a limited partner wants to sell his or her shares, the only allowable buyers are other partners.
For that reason, the IRS allows a discount on the value of a partnership share. The more complex and illiquid the asset: the bigger the discount. Generally, discounts range from 20% to 30%.
As well, general partners can reduce their share of the income by distributing to children. This, in turn, affects the general partner’s income tax since the general partner’s income can be reduced by distributing to children. It is important to note that there are age limits for shifting income to children.
Lastly, your value of partner interests included in the estate, for estate planning, wouldn’t change as the value rises over time. For example, if the initial partner interests were valued at $650,000 and over the course of 10 years rises to $5.5 million, only the initial $650,000 would be included in the estate at the time of passing. You can see the huge opportunity for tax savings.
FLP Asset Protection: Determining If a Family Limited Partnership Is for Your Business
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