There exists a variety of tax and non-tax reasons for the gloomy family business survival rate highlighted in "Fast Facts." One significant obstacle to successful family business succession is the repressive federal estate tax structure. Current estate tax laws can reduce a large estate by as much as 60%. An effective yet highly misunderstood technique to transfer a business or wealth within a family and legally avoid some taxes, is through a Family Limited Partnership (FLP).
The name may sound the same but the FLP is not a throwback to the old tax shelter days of the 1970s and early 1980s. For one, your partners are not unnamed investors from throughout the nation. In an FLP, your partners are your own family members. The investments are not New York skyscrapers or Texas cattle herds but may be your own family business or family interests. The potential tax benefits are not multiple tax savings based on deferrals and depreciation. Rather, the tax benefits that are available include estate tax savings and an ability to spread income tax burden among family members. Instead of no authority in partnership dealings, an FLP offers what matriarchs and patriarchs often seek in financial matters: CONTROL.
FLPs are generally established by parents who serve as general partners. Children usually obtain ownership in the FLP as limited partners. This structure allows for continued control by the parents since, as general partners, they establish the operating guidelines for the partnership.
The children become limited partners either through gifting or purchasing a partnership interest. In either case, parents are able to transfer partnership interests to younger generations at a substantial discount to face value. The discounts arise because it is usually difficult to sell a minority stake in a family business (AKA "lack of marketability") and because a child may have little say over partnership operations (AKA "minority discounts"). With both minority and marketability discounts considered, it is not unusual to enjoy a legal 25% to 35% discount on intra-family transfers.
One well known and highly publicized user of the FLP opportunity was the Walton family, Sam and Helen, of Wal-Mart Stores. Wal-Mart grew out of a family partnership that was established early in the Walton's business career. At the time of his death in April 1992, Sam Walton owned just 10% of the family Wal-Mart stock. Mr. Walton was quoted as saying, "The best way to reduce paying estate taxes is to give your assets away before they appreciate." Although the numbers are not the same as those of Sam and Helen Walton, follow this simple example:
Joe and Sue were each 50% general partners of ACME, a partnership valued at $3 million. They have five children and have established a Family Limited Partnership in order to pass the business ownership to their children. In this FLP Joe and Sue remain as the general partners, each retaining 20% ownership interests. They gift the remaining 60% of the business equally to the children in the form of five family limited partnership interests of 12% each. The face value of the gifts is $1.8 million (60% of the original $3 million). However, due to minority and marketability discounts, a discount rate of 35% is proposed, thereby reducing the total gift to $1.17 million. Using their available unified credit amounts of $600,000 each, Joe and Sue can transfer 60% interest in the business with no transfer tax costs. Meanwhile, Joe and Sue remain as the general partners and retain control of ACME.
If, as either a business owner or an individual of wealth, you wish to reduce your estate and transfer taxes yet want to retain control and, as an added benefit, receive some asset protection from creditors, an FLP may be an important tool in creating your family's wealth transfer plan.
