Key Takeaways:
- A family limited partnership (FLP) allows family members to combine assets under a centralized management structure.
- Parents may transfer limited partnership interests while retaining appropriate authority as general partners or through an entity they control.
- Lack of control and marketability may reduce an interest’s appraised value when supported by the facts and a qualified appraisal.
- An FLP requires a legitimate purpose, careful administration, and coordination with tax, business, and estate-planning goals.
High-net-worth families across Chester County, Montgomery County, and the Lehigh Valley may own investment portfolios, real estate, businesses, and other assets they eventually want to pass to the next generation. A family limited partnership (FLP) can provide a centralized structure for managing those assets and gradually transferring partnership interests to family members. It may also support estate and gift tax planning when transferred interests have genuine economic restrictions that affect their fair market value.
A Pennsylvania estate planning attorney can help determine whether an FLP fits the family’s assets, management needs, tax exposure, and long-term succession goals.
Table of Contents
What Is a Family Limited Partnership?
An FLP is a limited partnership in which family members own interests. Parents or grandparents may serve as general partners or control an entity that serves as the general partner, allowing them to direct the partnership’s investments, distributions, and other management decisions subject to the partnership agreement and their fiduciary duties.
Limited partnership interests may then be transferred by gift or sale to children or other family members, who receive economic and other rights defined by the partnership agreement but generally do not control day-to-day management.
The structure generally includes a general partnership interest carrying management authority and limited partnership interests carrying economic and other rights defined by the partnership agreement. The percentage allocated to each class depends on the family’s objectives and the structure selected.
How Valuation Adjustments Affect Estate and Gift Taxes
A potential transfer-tax advantage of an FLP arises when the fair market value of a transferred limited partnership interest is lower than its proportionate share of the partnership’s underlying assets because of genuine restrictions on control and marketability.
A qualified appraiser may evaluate two commonly discussed valuation factors, depending on the rights, restrictions, assets, and market evidence associated with the transferred interest.
Lack of Marketability Discount
A limited partnership interest in a private family entity generally has no established public market and may be subject to transfer restrictions under the partnership agreement. No stock exchange lists the interest, and finding a willing buyer may be difficult.
Because the interest may be difficult to sell, a qualified appraiser may determine that its fair market value is lower than the value of a readily marketable interest. The amount of any adjustment must be supported by the partnership agreement, the underlying assets, market data, and accepted valuation methods.
Lack of Control Adjustment
A limited partner generally cannot unilaterally direct distributions or investments and may have only limited authority to compel liquidation or dissolution under the partnership agreement and applicable law. These restrictions may reduce the interest’s fair market value. Any adjustment for lack of control must be determined through a fact-specific appraisal rather than a standard percentage.
If a qualified appraisal supports a value below the interest’s proportionate share of the underlying assets, the donor may report a smaller taxable gift than would result from transferring the assets directly, although the IRS may examine or challenge the valuation. The result depends on the specific interest transferred, the partnership agreement, the underlying assets, applicable restrictions, and the appraisal evidence.
Federal gift and estate tax rules are separate from Pennsylvania's inheritance tax. The Pennsylvania result depends on when partnership interests are transferred, what interests the owner retains, the relationship of the beneficiaries to the owner, and the value included at death.
Potential Asset Protection Benefits of an FLP
An FLP may provide limited protection against certain creditors of an individual partner, but it does not shield partnership assets from the partnership’s own creditors or protect transfers made to hinder existing creditors. A creditor holding a judgment against an individual partner generally does not obtain direct ownership of the partnership’s underlying assets merely because the debtor owns a partnership interest.
Under Pennsylvania law, a court may issue a charging order against a judgment debtor’s transferable partnership interest. The order creates a lien on the debtor’s transferable partnership interest and requires the partnership to pay the creditor any distributions that otherwise would have been paid to the debtor partner. A charging order does not by itself give the creditor the partner’s management rights or ownership of the partnership’s underlying property.
This structure may be relevant when a family member faces professional or business liability exposure, but it should be established for legitimate management and estate-planning purposes before any creditor claim arises. Contributing investment assets to a properly formed and operated FLP changes their ownership from direct individual ownership to partnership ownership, but the arrangement does not defeat existing creditor rights or protect the assets from liabilities incurred by the partnership itself.
For families with both business interests and investment assets, our business law services work in tandem with estate planning to coordinate FLP structure, buy-sell agreements, and long-term business transition planning.
What Assets Work Well in a Family Limited Partnership?
Depending on the partnership’s legitimate purpose and the legal, tax, lending, and operational restrictions affecting each asset, an FLP may hold assets such as:
- Investment portfolios (stocks, bonds, mutual funds)
- Commercial or investment real estate
- Private business interests that are not publicly traded
- Mineral rights and royalty interests
- Family vacation properties intended to stay in the family across generations
Primary residences, tax-qualified retirement accounts, and life insurance policies require separate analysis and are often handled through planning structures other than an FLP. Tax-qualified retirement accounts generally should not be retitled in the name of an FLP. A primary residence requires separate analysis because transferring it may affect mortgage terms, tax treatment, estate inclusion, creditor considerations, and the owner’s right to occupy the property. A QPRT or revocable trust may be appropriate in some circumstances.
IRS Scrutiny and How to Keep the Structure Sound
The IRS may examine family partnership valuations and seek to include contributed assets in the owner’s gross estate when the transfer does not qualify as a bona fide sale for adequate and full consideration or the owner retains possession, enjoyment, income, or the ability to determine who benefits from the property.
Common issues that may lead to IRS scrutiny include:
- Transfers near death. Forming or funding an FLP shortly before death may undermine the argument that the partnership had a genuine and significant nontax purpose.
- Commingling. Using FLP assets for personal expenses or failing to maintain separate accounts may indicate that the partnership is not operating as a genuine separate entity..
- Retained enjoyment or control. Continuing to use partnership assets personally, depending on partnership funds for living expenses, or informally controlling distributions may cause contributed assets to be included in the owner’s gross estate.
- Unsupported valuation. Claimed reductions in value may be challenged when they are not supported by a qualified independent appraisal, reliable market data, and the actual rights and restrictions attached to the transferred interest.
Maintaining the FLP as a genuine, functioning entity requires compliance with the partnership agreement, documented material decisions, separate financial records, appropriate tax filings, and arm’s-length dealings. Poor administration can lead to reduced or disallowed valuation adjustments, additional gift or estate tax, penalties, interest, or inclusion of contributed assets in the owner’s gross estate.
Integrating an FLP With Your Estate Plan
Forming an FLP does not automatically produce a valuation adjustment, reduce estate taxes, or protect property from creditors. Those potential benefits depend on the assets contributed, the rights transferred, the family’s reasons for creating the partnership, and how the entity is operated over time.
A Pennsylvania estate planning attorney at Ruggiero Law Offices can review your assets, family succession goals, potential federal estate and Pennsylvania inheritance-tax exposure, and business-management needs. The firm can coordinate the FLP with trusts, gifting strategies, buy-sell agreements, and other parts of a comprehensive estate plan.
