A family limited partnership (FLP) is a sophisticated legal structure designed to help families manage, protect, and transfer substantial assets—such as investment portfolios, real estate, or closely held businesses—across generations, while maintaining centralized management and pursuing estate planning and asset protection goals.
How an FLP Works
An FLP consists of two classes of partners. General partners oversee management, enjoy control, and generally shoulder unlimited liability (unless an LLC serves as the general partner). Limited partners—usually descendants—have ownership stakes but limited liability and no managerial authority. This setup often allows founders to gradually shift wealth to heirs through gifts of limited partnership interests, all while retaining day-to-day control.
Legal precedent highlights serious risks. For example, in Estate of Strangi v. Commissioner, the decedent pooled most assets into an FLP—continuing to live in property placed in the FLP and using partnership assets for personal expenses. The courts found this arrangement too closely tied to the decedent, disregarded valuation discounts, and included all FLP assets in the taxable estate. Similar unfavorable outcomes occurred in Estate of Powell v. Commissioner and Estate of Jorgensen—both struck down FLP structures for retained control, administrative informality, or lack of substantive business activity, again resulting in full estate inclusion.
Benefits of FLPs—With Important Caveats
- Asset Protection: A properly maintained FLP may shield assets from creditors, as creditors usually can only reach income distributions (charging orders), not force the liquidation of underlying assets.
- Estate and Gift Tax Efficiency: With careful planning, gifting limited partnership interests to heirs may allow use of valuation discounts. These discounts—applied for lack of control and lack of marketability—can lower the taxable value of transferred interests, provided the FLP is operated as a standalone business with clear non-tax purposes.
- Control Retention and Continuity: General partners retain operational authority, allowing families to centralize stewardship, coordinate succession, and uphold founder vision even as ownership shifts.
- Collaboration and Flexibility: Pooling assets and management can strengthen long-term strategy and family unity over successive generations.
Common but Contentious Example
In another situation, a family formed an FLP with marketable securities and real estate, aiming to equalize gifts to children and grandchildren while managing asset protection risks. However, FLPs built around passive investments—like securities and real estate—frequently face IRS scrutiny, especially regarding the application of valuation discounts and the legitimacy of business purposes. The IRS has a long track record of challenging these arrangements, questioning whether the FLP is a bona fide business or merely a tax device. If partnership formalities or authentic investment purposes are lacking, the IRS may disregard discounts and include all assets in the taxable estate—making rigorous compliance and careful structuring absolutely essential for these FLPs to be respected.
Challenges and Drawbacks
- Unlimited Liability for General Partners: Unless the general partner is structured as an LLC, founders face full personal exposure for partnership debts.
- Administrative Burdens: Proper FLPs require strict recordkeeping, documented meetings, meticulous agreements, and independent management of partnership versus personal funds. Any slippage can risk IRS or court disregard.
- Estate Tax Inclusion: As reinforced by Strangi, Powell, and Jorgensen, failure to establish a genuine business purpose, maintain outside assets, or respect partnership formalities can lead the IRS or courts to include all FLP assets in the taxable estate, eliminating perceived tax advantages and possibly adding penalties.
- State Law Variations: Asset protection, management rights, and procedural requirements vary by state. Some states provide robust shields; others offer less protection or stricter rules, necessitating careful formation and administration for each jurisdiction.
- IRS Challenge to Valuation Discounts: The IRS is notably aggressive in disputing discounts, especially when FLPs are formed late in life, are dominated by passive assets, or are used to accelerate transfers to heirs. Current law and pending legislation both threaten the continued ease of deep FLP discounts for estate and gift tax purposes.
- Setup and Maintenance Costs: Creating an FLP requires legal, appraisal, and accounting fees, usually amounting to thousands of dollars annually. For smaller estates or poorly managed FLPs, compliance and costs can outweigh any potential planning benefit.
Key Takeaway
A family limited partnership can serve as a sophisticated tool for asset protection, tax-efficient wealth transfer, and family management. However, the IRS and courts have repeatedly rejected FLPs that appear to be mere tax devices, are poorly documented, or allow creators to retain too much control—resulting in full estate inclusion as in the Strangi, Powell, and Jorgensen cases. Success requires bona fide business intent, continuous legal and tax compliance, and diligent respect for both partnership and local law formalities.