White Paper on
Family Limited Partnership Overview
Nicolosi & Associates White Paper
Family Limited Partnership Overview Introduction
A family limited partnership (“FLP”) is a statutory limited liability entity created
under state law. FLPs are named because ownership of partnership interests
typically is limited to members of the same family. Because of the many tax and
non‐tax benefits provided by a FLP, it is frequently used as the foundation of a
well‐organized estate plan. With proper planning, a FLP ensures the orderly
distribution of assets to subsequent generations at values that are reduced for
estate and gift tax purposes.
The purpose of this article is to provide a general overview of the use of FLPs in
estate planning. The concepts underlying FLPs are easy to understand and can
be used to create a powerful strategy for asset protection. We hope that this
article will be a useful source of information. Purposes And Uses
FLPs serve a number of legitimate business purposes; for providing continuous
ownership of property within the family unit; consolidating ownership;
providing a deterrent against postmortem asset ownership among family
members; deterring claims of creditors and spouses; limiting personal liability
for contract and tort damages; decreasing probate and estate administration
costs; and minimum guardianship costs for interests held by minors. State law
as modified by the FLP agreement governs ownership rights in the FLP.
Typically, parents form FLPs and contribute some of their assets to the entity.
The parents or one of the parents act as the general partners. Children and or
spouses are typically the limited partners. Often times the limited partnership
the founders of the FLP gift interests to the limited partners. The FLP agreement
sets out who will be responsible for managing the FLP assets and assuming
personal liability for FLP debts (“General Partner”). The personal liability of
those family members who give up day‐to‐day management rights and duties
(“Limited Partners”) is limited to the amount of capital which they contribute.
Since Limited Partner’s interests are typically gifted; they generally do not have
any liability to the creditors of the FLP.
Given that the underlying purpose of most FLPs is to plan for the transfer of
assets from parents to children, many parents are not willing to part with control
over their assets when the FLP is created. In some cases the parents simply
desire to continue managing the assets contributed to the FLP and in other cases
the children lack the maturity or business skills required to manage the assets.
In the latter case, a FLP usually provides the parents with the time and
opportunity to educate their children about managing the assets of the FLP.
In reviewing the various purposes for creating a FLP, the following reasons are
• To adopt a succession plan for the ownership, management and control of
• To ensure the orderly transfer of property interest to family members
while retaining control over the assets.
• To simplify annual gifting by parents.
• To reduce income, estate, gift and/or generation skipping taxes.
• To ensure that arbitration will be the method for resolving family disputes
over assets rather than costly litigation.
• To protect assets from creditors and from waste by the heirs.
• To consolidate asset ownership into a single entity.
• FLPs are more flexible than trusts in their operation and amendment.
The major benefits provided by a FLP are:
• Centralized management and continued control over assets by parents.
• Preventing undesired transferees from acquiring FLP interest.
• Ensuring continuous family ownership of assets.
• Reducing value of FLP interests for transfer tax purposes.
• Avoiding attachment of FLP assets by personal creditors of the partners.
• Providing income tax advantages as compared to other ways of holding
• Decreased investment and management costs for assets. Centralized Management and Continued Control
Control over assets contributed to the FLP is achieved by retaining ownership of
the General Partner/Managing Partner interest. Managing Partner
The most important decision to be made in creating a FLP is who to name as the
Managing Partner. The Managing Partner exercises exclusive control over the
partnership business operations and determines when, and how much of the
partnership income to distribute to the partners. As part of the FLPs succession
planning, a Non‐Managing General Partner will be named to succeed in the
duties of management and control upon the removal, resignation, bankruptcy,
dissolution, death or incompetence of the Managing Partner.
Possible Managing Partners include one or both parents (or the trustee of their
family living trust, corporations, limited liability companies (controlled by one or
more parents), children or grandchildren (or trusts for their benefit). However,
generally it is not recommended that children be given management powers
unless the parents expressly desire to relinquish control over their assets and the
child has sufficient experience and maturity in managing the FLP assets.
Even though much of the value of the FLP may be gifted away by transferring
limited partner interests to the children, the Managing Partner maintains control
of the assets in the FLP.
Duties and Responsibilities
The Managing Partner should have the necessary willingness, knowledge and
experience to do the following:
• Manage and invest partnership assets.
• Make decisions as to distributions of partnership income and/or assets.
• File income tax returns on behalf of the partnership.
• Furnish annual partnership income tax information (schedule K‐1) to the
• Make necessary filings with the Secretary of State.
• Give or withhold consent to transfers of partnership interests and
amendment of the agreement. Ensuring Continuous Family Ownership
Continuous family ownership of the FLP is guaranteed by restricting each
partner’s ability to sell or otherwise transfer his or her interest to non‐family
members. Because most FLPs are used by parents to transfer partnership interest
to their children at reduced transfer tax values, the existence of rights of first
refusal, buy‐sell provisions, or other restrictions on transfer are of paramount
concern and require considerable attention.
The FLP agreement should prohibit the partners from selling or transferring their
interest in a manner which is disruptive to the continuation of the family asset
arrangement plan or disruptive to family harmony.
Typically the FLP agreement will provide the partners a right of first refusal to
deal with a circumstance where one partner wishes to sell his or her interest to a
nonfamily member. In such cases the nonselling partners will have the right to
purchase the interest of the selling partner for cash or with an unsecured long‐
term promissory note which bears an interest rate favorable to the buyer. Only if
the nonselling partners fail to exercise their purchase rights may the interest then
be sold to the non‐family member.
If the family members do not wish for the new partner to possess any voting
rights, then the agreement should permit them to treat the new partner as a mere
assignee who is only entitled to receive income distributions and a proportionate
share of partnership income, expenses, deductions and credits.
This mechanism provides the family members with protection from the influence
of undesired active partners. In this way the FLP agreement promotes continued
family ownership and does not disrupt good asset management.
Reducing Values For Transfer Tax Purposes
An incidental but important benefit of a FLP is its reduction of values for estate
and gift tax purposes. Such reduction is a byproduct which accompanies indirect
ownership of assets in the FLP. As a general rule, the value of a FLP interest is
worth less than direct ownership of the same percentage interest in the
underlying assets of the FLP. This is because ownership of a FLP interest does
not convey any rights of management or control over the underlying assets
(except to the Managing Partner) and the agreement prohibits the partners from
freely transferring their interest to non‐family members. Conversely, transfer tax
values are reduced by the application of discounts (determined by appraisal) to
reflect these restrictions. Discount For Lack of Control
A discount for lack of control may be applied in establishing estate and gift tax
values of FLP interest. This discount reflects the inability of a limited partner to
control the operations of the FLP or to invest its assets in a manner which is of
greatest benefit to the limited partner. Because management and investment
decisions (including the decision as to when to distribute partnership income)
are outside the control and influence of the limited partners, the value of a
limited partner’s interest is reduced to reflect such lack of control.
Typical discounts for lack of control (minority interest) generally range between
twenty percent (20%) and thirty percent (30%). This discount is sometimes
referred to as a minority interest discount. Discount For Lack of Marketability
An underlying purpose of the family limited partnership is to maintain
ownership of assets for the benefit of members of one or more selected families.
Thus, the transfer of partnership interest to persons outside the family unit is
disfavored and, in extreme cases, may even be prohibited by the partnership
agreement Furthermore, private limited partnership interests generally lack
access to a readily available exchange for trading. For this reason it is said that a
limited partnership interest lacks marketability and is not easily convertible into
cash or cash equivalents.
This circumstance has resulted in further discounts in the range of 20% to 40%. Lock‐in Discount
Inability of partners to “cash out” their interests, restrictions on liquidation of the
partnership, rights of refusal and other transfer restrictions in the FLP agreement
reduce the value of a FLP interest for estate and gift tax purposes. Based upon
the number and severity of the transfer restrictions and on applicable state laws a
“lock‐in” discount may also be applied in determining the value of the FLP
interest for transfer tax purposes.
This type of discount may range from 10% to 30%. Asset Protection
FLPs provide a limited degree of protection for assets of the partnership since
these assets generally cannot be directly attached to satisfy personal debts of the
limited partners. Instead, the remedy of a personal creditor of one of the limited
partners is to obtain a “charging order” from a court against the interest of the
limited partner. The charging order entitles the creditor to receive the
distributions which would normally be paid to the limited partner until the debt
is fully paid.
A charging order, however, does not give the creditor any voting rights in FLP
matters. Further, the creditor is not assured that the Managing Partner will elect
to pay out the FLP income to the partners. Even though the Managing Partner
does not pay out any income to the creditor and other partners, the responsibility
for paying the income tax attributable to the attached limited partner’s interest
will fall upon the creditor. Thus, a creditor of a limited partner may be
persuaded to accept a lower settlement offer in satisfaction of the debt rather
than pursue a charging order.
How long this unique benefit will continue to exist is not clear. However, the
laws of most states continue to afford partnership assets this substantial degree
of protection. Income Tax Benefits
FLPs also provide a number of valuable income tax benefits to the partners.
Among these benefits are the following:
• Allows pass through of items of income, expense, credit and deduction to
• Permits “step‐up” in income tax basis in FLP assets for interests received
from a deceased partner
• Generally permits contribution, withdrawal of assets or partnership
liquidation without recognition of taxable gain, unlike corporate
• Allows income shifting since gifted FLP interests carry with them the
responsibility for a proportionate share of the partnership income.
These income tax benefits make FLPs extremely attractive in planning for income
tax responsibilities of the partners. If properly structured, the FLP will not
increase income taxes and may even reduce income taxes in some cases. Detriments
As exists with the formation of any entity, a FLP has some detriments. For
example, the following issues will generally be encountered:
• The FLP will have to pay minimum franchise tax fees for the privilege of
doing business in each state (approximately $300 annually in Illinois).
• The FLP must file annual income tax returns and keep separate
• The cost of formation and transferring title of assets into the FLP is
• Transfer of Subchapter S corporation stock to a limited partnership will
terminate the Subchapter S. election.