The Personal Trust Corner: A J.D.’s Perspective

Family Limited Partnership and Family Limited Liability Company

By Amy Piedmont, J.D., LLM, Vice President, Sr. Trust Relationship Manager and
Katherine “Kate” Gambill, J.D., Vice President, Sr. Trust Relationship Manager

In our series, “The Personal Trust Corner: A J.D.’s Perspective,” we aim to spotlight one planning strategy each month in response to the ever-changing Estate Tax Laws. This month, we turn the spotlight on the Family Limited Partnership, and Family Limited Liability Company.

Family Limited Partnerships (FLPs) and Family Limited Liability Companies (LLCs) are powerful tools for families looking to manage their wealth, protect their assets and plan for the future. These entities are particularly well-suited for several scenarios. For instance, FLPs and Family LLCs are often used in family business succession planning, allowing for a gradual transfer of control and ownership to the younger generation while enabling senior family members to retain control. Additionally, these entities can provide a level of asset protection, as creditors of a limited partner or a member of an LLC usually cannot reach the assets of the FLP or LLC.

FLPs and Family LLCs may also allow for valuation discounts for lack of control and lack of marketability, which can reduce the value of the taxable estate.

For families with significant wealth concentrated in real estate or a family business, these entities can be an effective way to manage and control these assets. They can also be used to consolidate family assets into a single entity that is easier to manage and control than many disparate assets. Furthermore, FLPs and Family LLCs can promote family legacy and values by keeping assets within the family and establishing a framework for joint family management of wealth.

There are several pros and cons to consider when evaluating FLPs and Family LLCs.

On the positive side, the older generation can transfer economic interest in the family business or other assets to younger family members while retaining control. These entities can provide a level of protection against creditors and potential litigants. Transfers of interests in FLPs or Family LLCs may qualify for valuation discounts for lack of control and lack of marketability, which can result in estate and gift tax savings. These structures can consolidate family assets into a single entity, simplifying management and governance. They can also be used to teach younger family members about managing family wealth and to promote family values.

However, there are some drawbacks to consider. Setting up and managing these entities can be complex and costly, often requiring ongoing legal, accounting and valuation services. Interests in FLPs and Family LLCs can be hard to sell, especially outside the family. Since the transfer of ownership interests is often restricted, raising capital can be difficult. The IRS closely scrutinizes FLPs and Family LLCs, especially those that claim valuation discounts, increasing the risk of an audit. As with any shared family endeavor, there's the potential for disagreements and conflict.

Valuation discounts can be applied when transferring ownership interests in entities like FLPs or Family LLCs that hold businesses or investments. One advantage of gifting partial ownership interests instead of cash is that assets may qualify for a valuation discount because the minority interests lack management control and marketability. This discount is often justified at around 30%, though it varies case by case. These discounts provide an opportunity to transfer more assets, along with their future appreciation, out of the donor's estate, potentially reducing estate taxes.

Careful Planning is Key

When drafting an FLP or Family LLC, your attorney will work with you to help you understand the tax implications. Tax benefits include valuation discounts for transfer tax purposes, allowing clients to gift assets at a lesser value. Non-tax benefits might involve consolidating diverse holdings for ease of management, involving the next generation in asset management, and protecting assets from creditors and failed marriages.

Selecting the appropriate jurisdiction is crucial. A state with strong fiduciary duty policies, asset protection and an experienced judiciary can provide significant business-centric benefits. The choice between an LLC and an LLP should be based on your specific needs and priorities.

The operating agreement can be carefully drafted to establish formalities and avoid estate tax inclusion under IRC § 2036(a)(1). It should list non-tax purposes and describe governance procedures. The operating agreement should also include valid non-tax purposes, such as consolidating fractional interests in family assets, promoting family knowledge and communication, and managing investments for capital growth.

Decisions about who will exercise control over the LLC are crucial. Careful drafting is necessary to avoid granting the client management powers that could lead to estate inclusion under IRC § 2036(a)(2). To avoid estate inclusion issues, your attorney may consider foregoing certain powers, such as making distributions, dissolving the entity, or admitting members. Naming a Board of Managers with an Independent Manager can help mitigate these risks.

The Board of Managers may appoint officers to handle strategic goals and administrative formalities. Typical roles include President, Secretary, and Treasurer, each with specific responsibilities.

Successful formation and operation require careful administration and adherence to the operating agreement. Key steps include obtaining federal EIN, retitling assets, maintaining bank accounts, conducting meetings and complying with tax reporting. Ensure all necessary licenses and registrations are filed, establish legitimate non-tax reasons for the LLC, and execute the governing operating agreement. Respect the formalities of the operating agreement, retitle assets, maintain bank accounts, conduct meetings and comply with tax reporting.

In conclusion, FLPs and Family LLCs offer a range of benefits for families looking to manage their wealth, protect their assets, and plan for the future. While they come with certain complexities and potential drawbacks, their advantages in terms of control retention, asset protection, and tax savings make them valuable tools in family wealth management. If you're considering these entities, it's important to consult with legal and financial professionals to ensure they align with your family's goals and circumstances.

At Personal Trust, our commitment is to guide you through this intricate landscape, helping you achieve ideal outcomes.

Please reach out to our Senior Trust Relationship Managers: Amy Piedmont, J.D., LLM, Vice President, in Pensacola, Florida and Katherine Gambill, J.D., Vice President, in Atlanta with any questions or to start a conversation regarding estate planning. We welcome the opportunity to introduce you to how Synovus Trust Company can serve your needs.