Family Limited Partnerships (FLiP)

FLiPs, or Family Limited Partnerships, are one of the most talked about but seldom seen wealth transfer strategies. FLiPs are designed to reduce the value of your estate (for estate tax purposes) while allowing you to maintain full control of investments and assets inside the Partnership.

In the early 1980's, Limited Partnerships were sold left and right. Less than a decade later, the popularity of Limited Partnerships had plummeted, as investors disappointed by little or no growth of Partnership assets had difficulty getting their money out. The same features that made Limited Partnerships unattractive as investments make Family Limited Partnerships very attractive for estate planning purposes.

The Basics of FLiPs

FLiPs are setup much like traditional limited partnerships. There are two parties involved: "General Partners" which control the trust, and "Limited Partners" who have a share in the profits (but hold not control).

A typical FLiP is setup in this way:

How It Works: 1. Business converted to Limited Partner and General Partner shares. 2. You maintain control by keeping General Partner shares. 3. Use your annual gift exclusion of $11,000 to gift away Limited Partner shares to your family and heirs. Who Maintains Control? You do.

Two Types of Partners

The General Partners (you and/or a spouse) design the partnership to gift Limited Partner shares to family members. General Partners control the operations of the FLiP and make day-to-day investment decisions. They can also receive a percentage of the FLiP's income in the form of a management fee.

Limited Partners (your heirs) have an ownership interest in the FLiP, but they have very limited control. They share in the income generated by the FLiP, depending on how many shares of the FLiP they own. But, as far as control goes, they have almost no say. When the FLiP is dissolved, a proportionate amount of FLiP property will pass to each Limited Partner.

Setting Up a FLiP

Like most estate planning documents, creating a FLiP requires the help of an experienced estate planning attorney. With the attorney's assistance, you place your assets within the FLiP using your unified credit. For instance, a husband and wife can each transfer up to $1,000,000 ($2 million total) into the FLiP and allocate those assets to the Limited Partnership side. They can then place an additional $12,000 in the FLiP for the General Partnership side. There are no taxes incurred when funding a FLiP with your assets.

In the beginning, you and your spouse own both General Partner and Limited Partner shares. Over time, you gift to your heirs Limited Partner shares using your annual $11,000 gift exclusion. Don't worry about giving away too much of the shares. The General Partners may own as little as 1% of the FLiP's assets and still retain control. That means you can still buy and sell assets, dispose of property, and declare any distributions of FLiP shares.

Leverage Your Unified Credit

FLiPs allow you to pass on more than the maximum $1 million ($2 million per couple) Unified Credit. A gift of Limited Partnership assets of $1 million, in some cases, may be appraised at a substantially lower dollar amount. After all, the shares lack any control and cannot be sold to others. In other words, there is no "market" for Limited Partner shares. This lower appraisal is called "discounting" the value of Limited Partnership units.

Thanks to discounting, some grantors are able to gift approximately $800,000-$900,000 to your children as Limited Partners, and still have it qualify as gift tax-free and estate tax-free. To determine whether your estate might qualify, your attorney.

Hedge Against Creditors

Because of their lack of control, Limited Partner shares are very undesirable to creditors. Creditors also cannot seize Limited Partner shares, since they are not publicly traded.

Creditors also don't want to pay tax on income they don't receive. If the Partnership has earned income, but the General Partner does not declare a distribution, each General and Limited Partner is required to report a proportionate share of the earned income on his or her personal tax return, without actually receiving any dollars with which to pay the tax. This creates "phantom income" for the Limited Partners.

Imagine how upset a creditor would be to learn that he seized Limited Partner units, only to be deprived of control, income, and dissolution rights... and then find out he must pay tax on a significant amount of income that technically doesn't even exist yet!

FLiPs Offer Other Advantages

Another important feature of FLiPs is that they are considered an "intangible asset." Thus, chances are that only the state of your domicile will be able to impose any inheritance tax on Partnership units. This is ideal for real property owners that own property in several states.

Another Source of Retirement Income

FLiPs, as mentioned before, can provide General Partners with a stream of income as a "management fee." This fee reflects the work you do as the General Partner, and is considered earned income.

You may also draw income from your FLiP through a Preferred Payment Provision. Such a provision could allow you to pull a pre-determined amount each year from the Partnership's income. For instance, you could structure a FLiP to pay you $50,000 per year for 10 years, for a total of $500,000. Just like the management fee, preferred payments are subject to income tax. Preferred payments reduce the value of the FLiP, allowing you to possibly utitlize other wealth transfer strategies.