A family limited partnership generally has specific assets to fund its operations. While real estate is a great investment option, not all assets can be transferred to the partnership. A partnership cannot hold stock of an S-corporation partner. When they give property in exchange for partnership interest, partners do not realize gain or loss. The partnership and partners do not experience any gain or loss from capital additions.
A partner who contributes capital and assets to the partnership is granted an interest. The percentage contribution of the partner in all contributions will determine the share. Additional contributions to the partnership will raise their share. Other shares should be adjusted in accordance.
Giving of partnership units
Splitting partnership interests into units is easy and allows for the transfer of assets to loved ones within the annual gift tax exclusion. This exemption is $14,000 per donee per year in 2014-2015, or $5,340,000 per donee in 2015. For gift tax purposes, there are discounts available that can be used to decrease the partner units’ value by between 20 and 40 percent.
There are three types of valuation methods that can be used to calculate the fair Market value for an interest in closely held entities. The Market method is also known as the comparable sale method. It compares the close-held company’s stock value with that of similar businesses with stock values.
Income (or discounted cashflow) is a method that discounts the future earnings of the stock company to which it’s being valued. The net asset (or balance sheet), method is based on the total value of all assets less liabilities.
When a closely held business is involved in active trading or business, the Market or Income method will be most commonly used. When a close-held company holds only real estate and investment assets, but does not trade or operate a business, the net asset value will be most commonly used.
Gifts to donees are valued at the present fair market value, and not the current fair Market value. The IRS has accepted that a minority share in a limited partnership, with restricted ownership rights for the limited partners, qualifies to receive a discount from the fair Market value the underlying assets. Revenue ruling 93-12. The gift-tax exclusions allow parents to give more to their kids without losing control.
To be eligible for the discount, the limited partner’s interest must be considered a minority interest (lack-of-control discount) and/or not freely transferable (lack-of-Marketability discount). IRC §2036(b) includes gifts in the donor’s taxable estate of corporate stock in a controlled corporation in which the donor retained the right to vote the stock. Partnership interests are not covered by the corresponding section of the tax code.
To qualify for the current equivalent of the unified credit exemption, donors may wish to make gifts or transfers to limited partnerships units. While these gifts do not need to fulfill the same criteria as present-interest gifts they are often used for estate elimination upon death. The estate will not include gifted units of partnership, regardless of whether the donor is still a general partner in the partnership or acts as an agent for the benefit of all other partners.
Family Limited Partnership
The parents can accept an equal salary as general partners to help them manage the business. The parents can also determine whether income will be preserved or allocated to partners. They can also loan money to limited partners. They can use the money to help their parents or to fund retirement. This is subject to certain fiduciary requirements (lower than for trustees). The IRS and State that the partnership operates in dictates withholdings for salaries paid to any member of the partnership.
Partnerships are required to submit tax returns each year. Federal form 1065 is required. The State returns the same form. Each partner must include any income they receive on their tax returns. No distributions are made, but the income must be claimed by all partners on the form K1 provided by the partnership.
Family Limited Partnership Taxation and Insurance
In the context of income taxes, assets passed from the partnership into the hands of the partners will retain their original nature. IRS Revenue ruling (83-147) explains how life insurance that a partnership owns on behalf of one of its members is subject to estate tax. It should look the same as corporate life insurance. The insurance death benefit of life insurance will only be added to the estate of the partnership if the partnership is the beneficiary.
To avoid increasing the partner’s partnership interest by a percentage of the income from life insurance, the policy can list the children of deceased partners as beneficiaries and owners of the policy. As limited partners, general partners are able to distribute the income to the children to help pay premiums. If the grantor dies before the beneficiary, they can control the succession of the beneficiaries. This would help preserve cash value in the case that the child is divorced.
Family Limited Partnership: The Risks
Without administrative hearings the IRS issued new regulations in accordance with Subchapter K (IRC) without delay. Summary: The IRS will not consider a partnership an entity if its principal purpose was to avoid income taxes at the inception of operation. Proposed regulations apply only to income taxes and are not applicable to estate- or gift-tax valuations. The IRS may address future estate or gift valuations, but this doesn’t mean they won’t. The costs of forming an FLP and keeping it up are:
• Attorney fees to form the partnership (however an attorney is not required
• Appraisal fees for underlying assets and for the partnership “slices”it is given to family members of the younger generation;
• Accounting fees for partnership K-1’s and other financial assets;
When transferring property, transfer taxes such as document stamps can be costly. However, many investors find the rewards of FLPs well-planned to outweigh both the risks and the cost.