Family Limited Partnership (FLP): Definition, Pros & Cons

What Is a Family Limited Partnership (FLP)?

A family limited partnership (FLP) is an arrangement in which family members pool money to run a business project. Each family member buys units or shares of the business and can profit in proportion to the number of shares they own, as outlined in the partnership operating agreement.

Understanding a Family Limited Partnership (FLP)

Family Limited Partnerships have two types of partners. General partners usually own the largest share of the business and are responsible for day-to-day management tasks such as overseeing all cash deposits and investment transactions. The general partner may also take a management fee from profits if outlined in the partnership agreement.  Limited partners have no management responsibilities. They instead buy shares of the business in exchange for dividends, interest, and profits the FLP may generate.

FLPs vary depending on the nature of the business. For example, suppose an individual wants to start a luxury apartment venture. They expect the project to cost $1 million, including working capital, and take in about $200,000 in cash each year before interest on mortgage payments and taxes. They calculate that they'll need at least a 50% down payment of $500,000. So, they call some family members, and they all agree to establish an FLP that will issue 5,000 limited partnership shares at $100 each for a total of $500,000. The limited partnership agreement states that units cannot be sold for at least six years, and the FLP will pay 70% of cash earnings in the form of dividends.

As the general partner, the original individual who made the calls buys 500 shares by contributing $50,000 to the FLP. Family members buy the remaining shares. Now, each family member owns a stake in an FLP starting at $500,000. Next, the general partner might get a first mortgage loan for the rest of the $500,000 to start the $1 million luxury housing project.

The FLP then leases these apartments to tenants and begins taking income from rent. As the mortgage is paid off, profits and dividends are distributed, and each family member grows wealthier.

Advantages of Family Limited Partnerships

There are some estate and gift tax advantages of a family limited partnership. Several families establish FLPs to pass wealth down to generations while securing some tax protections.

Individuals can gift FLP interests tax-free to other individuals every year up to the annual gift tax exclusion. For calendar year 2022, the gift exclusion is $16,000 for individuals (or $32,000 per married couple). This increases to $17,000 for calendar year 2023 (or $34,000 per married couple).

Suppose a couple amassed savings worth $5 million. They have three children and nine grandchildren. The couple decides to transfer the entire amount to the FLP they established. Each year, they gift $34,000 worth of FLP interests to each of their 12 kids or grandkids. This means the couple can transfer $408,000 worth of FLP interests gift-tax-free every year (assuming the gift tax exclusion remains the same).

Disadvantages of Family Limited Partnerships

There are downsides to creating an FLP. First, it can be expensive to set up and maintain because of its complexity. Most often, setting up an FLP will call for a tax specialist and estate planning attorney, and you may need to call on other professionals associated with helping to support an FLP. In addition, because an FLP has to run (for tax purposes) as a business, it could expose you or other family members to liabilities and debts, if it is mishandled in any way by any member of the family. In addition, there may be capital gains liability and it can be difficult to transfer ownership interest to minors.

Special Considerations

In addition, these assets effectively leave the couple's estates, as far as the IRS is concerned, so that any future returns would be excluded from estate taxes. The couple's children and grandchildren would benefit from any interest, dividends, or profits generated from the FLP—thereby preserving wealth for future generations. 

As general partners, the couple can set stipulations in the partnership agreement to protect these gifts from being squandered or mismanaged. For example, they can develop a rule stating that gifted shares can't be transferred or sold until the beneficiaries reach a certain age. If any beneficiaries are minors, the shares can be transferred through a Uniform Transfers to Minors Act (UTMA) account.