Limited liability companies (LLCs) and family limited partnerships (FLPs) are entities commonly used in the estate planning context, with ownership generally limited to members of one family. An LLC or FLP can provide important tax and non-tax benefits. From a non-tax standpoint, these entities are important in that they can provide a vehicle for managing family assets, and can protect from liabilities arising in connection with the assets held in the FLP or LLC. They can also provide asset protection, in that a creditor who seizes the partnership interest from the interest holder will succeed only to the interest holder's rights, and may not be able to force a liquidation of the partnership or LLC (making it a much less attractive asset to seize.) Thus, an FLP or LLC is an excellent way to own buildings or an unincorporated business. From an income tax standpoint, an FLP or LLC can be superior to a corporation because they are treated as pass-through entities. From a gift and estate tax planning standpoint, an FLP or LLC can give rise to significant valuation discounts.
More specifically, a limited partnership, if used properly, can be an excellent asset protection tool that operates in a manner comparable to that of an LLC. A limited partnership consists of one or more general partners and one or more limited partners. The general partners have management power in the partnership, with no liability protection. The limited partners have no management power in the partnership, but they do have liability protection. A typical limited partnership will have a general partner with a 1% membership interest in the company, and all the other partners will usually be limited partners, who collectively hold the remaining 99% interest in the company.
A family limited partnership is essentially a limited partnership with family members as the partners. The children are usually the limited partners, and a parent, trust or other business entity is usually the general partner. FLPs are generally used for estate planning and asset protection purposes. With an FLP, assets are typically gifted from the general partner to the limited partners, using the donor's annual exclusion and/or lifetime exclusion from gift tax.
In many respects, a limited partnership works like an LLC. Limited partnerships benefit from pass-through taxation, and in most states, creditors are only entitled to distributions from the partnership, without being able to seize the partnership’s assets or gain a partnership or management interest in the limited partnership.
In an LLC or FLP, control of the company can be, and frequently is, divorced from equity. An LLC is controlled by a manager or managers, who may or may not be members. An FLP is controlled by its general partner(s). Managers and general partners do not have to be elected by a majority of members or limited partners; they can be named in the operating agreement or limited partnership agreement. An LLC member may own 99% of the equity, yet have no control over the LLC because he or she is not a manager. Likewise, a limited partner in an FLP may own 99% of the equity and have no control because he or she is not a general partner. This inherent separation of control from equity ownership makes an LLC or FLP an ideal gifting vehicle. These types of entities allow a donor to gift away almost all of the equity value that would be included in his or her taxable estate, without relinquishing control of the underlying assets.
As referenced above, LLCs and FLPs lend themselves in estate planning to taking advantage of valuation discounts. Thus, when gifting away the equity value that would otherwise be includible in a donor's estate, the value of the gift of LLC or FLP interests may be discounted for one of the following inherent reasons:
Lack of Marketability. An interest in an entity that is not registered and readily tradable (e.g. stock in a publicly traded company) cannot be easily sold and converted to cash because there is no market for the interest.
Lack of Transferability. Even if there were a market for the interest, a member of an LLC or partner in an FLP cannot readily transfer his or her interest because admitting a new member or partner requires the approval of the other members or partners under state law. Additional restrictions on transfer are often imposed in the LLC operating agreement or FLP partnership agreement.
Lack of Control. An interest holder in an LLC or FLP cannot compel the entity to liquidate and pay out the value of the holder's interest.
Discounting can be a very useful tool in designing a gifting program using the annual exclusion and/or lifetime exclusion from gift tax. Discounting takes maximum advantage of the annual exclusion and lifetime exclusion by allowing more interests to be transferred. In order to determine and value the discounts that may be taken, it is important that the donee obtain a written appraisal of the LLC or FLP interests from a qualified appraiser.