Take care in establishing family limited partnerships

A family limited partnership is one where most of the partners are members of the same family group, and where one member – generally a parent – manages the business as a general partner, while the other family members are limited partners. Although in recent years the Internal Revenue Service has come to realize that the FLP is a legal tax strategy that provides a way to protect a family's assets, it has developed a number of tactics to challenge the validity of a partnership arrangement to curb tax shelter abuse, said James Dean Spratt Jr. of King & Spalding during a recent ABA continuing legal education teleconference on "Estate and Gift Tax Implications of FLPs."

The panel of experts, consisting of tax, estate planning, and trust administration lawyers, provided insightful information on why families form FLPs, how to avoid potential IRS attacks, and operation of the FLP.

The most popular reason for forming an FLP is because the structure allows senior family members to retain control while they're still living. Other reasons include simplification of annual gift giving, the ability to transfer wealth without negating the recipient's incentive to be productive, lower operational costs and increased ability to increase diversity of investment, and protection against the transfer of assets outside the family.

Correct formation of an FLP is essential to guard against challenges by the IRS. The panelists provided a list of the "Top 10 Issues Regarding the Formation of Family Limited Partnerships." On the list are cautions against a lack of financial participation by others, which causes estate tax concerns to arise if there is no true pooling of family assets; FLP in-a-box, or firms promoting FLPs based on a flat fee basis using prepackaged forms; and deathbed FLPs, which the IRS views as a partnership solely formed to avoid taxes.

But the formation of an FLP is only half the battle. Operation and liquidation must also be seriously considered, said William S. Forsberg of Parsinen Kaplan Rosberg & Gotlieb. Partners in the FLP entity must treat it like any other business, with regular meetings and record-keeping; must demonstrate that there is a valid business purpose for establishing and operating the FLP; and must actually manage FLP assets through the FLP, not through the transferor.

Selected materials from the teleconference are available here [PDF] until at least September 12. Audio of the program and other program materials are available through the ABA Web Store, here.

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