A Family Limited Partnership is an entity formed as a statutory limited liability partnership under state law (Ohio: Ohio Rev. Code Ann. Sections 1782.01 through 1782.62 (Page Supp. 1984) effective April 1, 1985) in which the only partners are family members or family trusts.

The primary objective of a Family Limited Partnership is to carry on a closely held business where control and management is extremely important, or to maintain a closely held business in which the limited partners have no personal liability for the debts and obligations of the partnership.

The primary benefit this estate planning tool offers is the ability to reduce the estate tax burden by as much as 35 percent or more, while protecting family financial assets from a predatory legal system.

Unlike many financial and estate plans, Family Limited Partnerships leave room for individuals to change their minds. Because of the plan's flexibility, participants are not locked into a predetermined course of action developed prior to knowledge of changing facts and circumstances.

Two significant United States Tax Court decisions, in 1985 and 1987, established a precedent of valuation discounts for limited partnerships. About the same time, an important revision of the Uniform Limited Partnership Act (RULPA) became the law in most states. RULPA provides a method to limit the rights of judgment creditors to limited partnership interest.

As a result of these decision, the potential of the Family Limited Partnership became extremely powerful, so powerful in fact that many, at first, dismissed it as "too good to be true."

Now, the Family Limited Partnership is recognized as a viable and valuable planning opportunity.

The Family Limited Partnership is not difficult to understand, nor is it difficult to use.

In a typical case, Mom and Pop transfer property to a partnership that they form. Their assets may be marketable stocks and bonds, cash, the family farm, or stock in the family business. Mom and Pop no longer own these assets. They receive, in exchange for their contribution of property to the partnership, units of ownership in the Family Limited Partnership.

They can give or sell their units to members of their family or to the family members' trusts. Otherwise, the units of ownership are non-marketable and non-transferable. Outsiders cannot buy these units without the consent of all family partners.

In a Family Limited Partnership, the general partner has the responsibility for management and assumes personal liability for the debts and obligations of the partnership. The limited partners have no say in the management, but their liability is limited to their investment in the partnership.

TWO KEY FACTORS EXPLAIN WHY THE FAMILY LIMITED PARTNERSHIP IS SO POWERFUL

1. A general partner, with as little as one percent interest, has control over management of partnership assets. Limited partners, with as much as the remaining 99 percent interest, have no management duties.

2. The cumulative fair market value of all partnership units is less than the underlying asset value of the partnership. This is so because of the valuation discounts resulting from lack of transferability of ownership units and the characterization of the partnership interest as a minority interest.

The Family Limited Partnership presents amazing planning opportunities. A brief overview of the tax and non-tax considerations are listed below.

PLANNING CONSIDERATIONS

THE GIFT OF PARTNERSHIP INTEREST IN LIEU OF FAMILY ASSETS

The Family Limited Partnership facilitates the gifting of an indivisible family asset or the combination of various family assets into one gift.

THE ABILITY TO CONSOLIDATE OWNERSHIP OF FAMILY PROPERTY AND PROVIDE MANAGEMENT AND CONTROL OF SUCH ASSETS

Consolidation of family assets into a single Family Limited Partnership may lead to significant operational advantages.

RETENTION OF PARTNERSHIP INCOME

The parent, as general partner, can control cash flow from the Family Limited Partnership by retaining income for the partnership's business needs.

VALUATION DISCOUNTS

Limited partnership interest normally carries restrictions and limitations on ownership (as specified in the partnership agreement). Since Family Limited Partnership interests are not freely alienable, few buyers are willing to pay full value (based upon the underlying asset value of the business) for a non-controlling interest in a business entity bearing such restrictions and limitations. The interest is marked down to reflect such interest.

ASSET PROTECTION

In the absence of fraud, the Family Limited Partnership may provide protection of family assets from future creditors and some protection against losing assets in divorce actions, if there are failed marriages.

ESTATE PLANNING ASPECTS

The Family Limited Partnership provides for the key estate planning objectives: flexibility and control plus, through valuation discounts, reduction of the Federal estate tax liability. In many cases the Family Limited Partnership provides an attractive alternative to an irrevocable life insurance trust (Crummey trust).

TAXED AS A PARTNERSHIP

It is extremely important that the terms of the partnership be structured to avoid treatment as an association (taxed as a corporation). The organization will be taxed as a partnership if it posses no more than two of the following corporate characteristics: continuity of existence, centralized management, limited liability and freely transferable interest. IRS REG. 301.7701-2(a), 301.7701-3(b).

SHIFTING OF INCOME BETWEEN FAMILY MEMBERS

The partnership itself is not subject to tax, but each partner reports his or her proportionate share of partnership income or loss. IRS Form 1065; IRS Form K-1.

INCOME SPLITTING

This is possible, if the partnership income is attributed to capital. A person is recognized as a partner for income tax purposes if he or she owns a capital interest in the partnership, regardless of whether or not such interest is derived by purchase or gift. Treas.Reg.1.704(e)(1).9.

However, if the partnership is a service-oriented business where income derives from personal services performed by members of the partnership, income must be allocated to the partner generating the service income. IRC 61.

NO RECOGNITION OF GAIN ON APPRECIATED PROPERTY

The partnership does not recognize gain when it distributes appreciated property.

CASH DISTRIBUTIONS NOT GENERALLY SUBJECT TO INCOME TAX

A cash distribution to a partner will not create taxable income (because the partner is taxed directly on partnership profits annually).

RETURN OF CAPITAL RESTRICTION

The Family Limited Partnership Agreement may be written to limit a partner's right to demand the return of any part of his or her contribution except in dissolution or liquidation.

The obvious advantage is that a creditor of the partner cannot reach the capital contributions of the debtor partner. A creditor cannot obtain greater rights to assets owned by the partnership than a debtor-partner. Thus, since a partner does not have a right to assets owned by the partnership, the creditor cannot reach specific partnership assets.

DISTRIBUTION OF PROFITS

The agreement may give the general partners the ability to retain the limited partnership profits and transfer those profits to the limited partner's capital accounts for reasonable needs of the business.

VOTING PROVISIONS

The Family Limited Partnership Agreement can require a high percentage of ownership interest for voting purposes to ensure that the limited partners cannot override the provisions of the partnership agreement or general partner decisions.

FAILED MARRIAGES

Even if a divorce court rewards part of the limited partnership interest to a divorced spouse, a partnership agreement can provide that involuntary transfers will be subject to the buy-sell agreement of the partnership agreement. The partnership interest will be bought by the other partners, or the divorced partner, at its fair market value.

ASSIGNMENT OF LIMITED PARTNERSHIP INTEREST

The partnership agreement may restrict voluntary or involuntary assignment of a limited partner's interest.

RIGHTS OF CREDITOR

Without consent of all partners and a provision in the certificate of limited partnership, the partner can transfer only his or her share in the profits (RULPA 704). The assignee does not become a substitute limited partner and is not entitled to exercise any rights as a partner.

CHARGING ORDER

Generally, a "charging order" is the only means by which a creditor of a partner can reach the partnership interest of the debtor-partner. This "charging order" does not allow the creditor to reach the assets of the partnership, nor does it allow the creditor to become a partner. But it does entitle a creditor to receive such debtor-partner's share of profits and distributions.

Even with a "charging order" in effect, the general partner remains in control and continues to make decisions regarding management of the Family Limited Partnership. A creditor receives funds only if there are distributions, and the creditor cannot demand partnership distributions. This may force the creditor to pay income taxes on his or her share of the partnership's taxable income (form K-1) even though the creditor did not actually receive any cash distributions.

LAYERS OF PROTECTION

There are two layers of protection: The individual family members no longer have legal or equitable title to the assets contributed to the family partnership; divesting legal title to personally owned assets is the first line of protection. The second line of defense is that transfers made for legitimate business and estate planning purposes will be perceived as lawful.

After the Family Limited Partnership has been valued in accordance with normal valuation principles as outlined in Rev. Rul. 59-60, the value of a partner's interest will be adjusted for various factors, including control, minority status, lack of marketability, or restrictions in buy-sell or other agreements.

LACK OF MARKETABILITY DISCOUNT

Lack of marketability discount exists because few buyers are willing to pay full value (based on underlying net asset value of the business) for a non-controlling interest in a business entity bearing so many restrictions and limitations.

MINORITY, NON-CONTROLLING INTEREST DISCOUNT

There is a minority discount when a minority owner does not have the ability to force a liquidation or dissolution to receive his or her pro rata share of partnership net assets and lacks control over items such as business policy, distribution payments and compensation matters. For such reasons, shares representing a minority interest in a limited partnership interest will almost assuredly be less than the simple pro rata value of the business.

NO NECESSITY OF AGGREGATING FAMILY INTEREST

The IRS has finally agreed that family members' interests need not be aggregated to determine whether a particular interest is entitled to a minority and/or marketability discount. Rev. Rul. 93-12, I.R.B. 1993-7.

Appropriate "lack of marketability" and "minority interest" discounts suggest that a 30 to 35 percent discount is not excessive.

REDUCTION OF FEDERAL ESTATE TAX

A primary benefit of the Family Limited Partnership is its ability to reduce Mom and Pop's taxable estate. Mom and Pop establish a "planned gifting" program to divest themselves of their limited partnership interest. This will reduce their gross estate, yet as general partners, they continue to manage and control the family assets.

IN LIEU OF FAMILY ASSETS

The Family Limited Partnership facilitates the gifting of an indivisible family asset or the combination of various family assets into one gift.

RETENTION OF CONTROL BY DONOR

If the donor remains a general partner and limited interests are given to family members, the donor retains "effective control" over partnership assets.

ASSET PROTECTION OF THE DONEE'S INTEREST

A typical Family Limited Partnership will have restrictions on the ability of a limited partner to dispose of his or her interest. These limitations tend to preserve the property that has been gifted to the donee.

FUTURE GROWTH AND APPRECIATION

If the underlying assets of the partnership appreciate in value, the donee's limited partnership interest will also appreciate in value. This increased value will occur gift tax free.

LEVERAGING THE GIFT TAX VALUES

For valuation purposes, a limited partnership interest that is gifted will be valued after taking into account the lack of marketability discount and the minority interest discount. These discounts make the gifting of a limited partnership interest more attractive because more value can be passed out of the donor's estate at a lower gift tax cost.

There are two major concerns regarding life insurance on a general partner when the limited partnership is the owner, premium payor and beneficiary.

1. Will the management and control of all partnership assets (including life insurance) be sufficient to have the proceeds included in the decedent's estate?

2. Will the proceeds be included under the three-year rule if the policy was purchase by or transferred to the partnership within three years of the date of death?

INCIDENCE OF OWNERSHIP

The death proceeds will be included in the decedent's estate if the proceeds were payable to, or to the benefit of, his or her estate, or if the decedent possessed any incidence of ownership in the policy.

Where the limited partnership is the owner and beneficiary of a policy on the life of a general partner, any "attribution" of the partnership's incidence of ownership should not occur.

Treas. Reg 20.2042-1(c)(6) takes this position with regard to a corporate situation, and the Tax Court has taken a similar position in Estate of Frank H. Knipp, Deceased, 25 T.C. 153(1955) acq. in result, 195901 C.B. 4.

TRANSFERS WITHIN THREE YEARS OF DEATH

If the insured sells or contributes an existing policy to a partnership in exchange for adequate and full consideration in money or money's worth, the proceeds will not be included in the insured's taxable estate. This is true even if the transfer occurs within three years of the insured's death. Likewise, the transfer for value exception under IRC 101(a)(2)(B) will apply so the insurance proceeds will be excluded from partnership income.

FEDERAL ESTATE TAXATION

The value of a decedent's gross estate includes the value of all property to the extent of the decedent's interest at the time of his or her death. This includes the fair market value of the decedent partner's interest. The fair market value of the decedent partner's interest. The fair market value of a decedent' interest is the amount a willing buyer would pay for the interest to a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts. Treas. Regs. 20.2031-2, 20.2031-3.

In valuing a decedent's partnership interest, consideration must be given to non-operating assets, including proceeds of life insurance policies payable to, or to the benefit of, the partnership. However, the proceeds are limited to the extent that such non-operating asset has not already been taken into account in determining the net worth of the decedent. The Treasury regulation does not intend that business-owned non-operating assets are to be included more than once in determining value. Treas. Reg. 20.2031-2(f).

Therefore, if the valuation considerations set forth above are applied, one would include within the value of the deceased partner's interest a share of the insurance proceeds payable to the partnership interest. For example: if the decedent had a 2 percent general partner interest in a limited partnership and the partnership had a $1,000,000 policy on his life at the decedent's death, only $20,000 of the proceeds would be includable in his or her estate for Federal estate taxes.

INTEGRATION OF A FAMILY LIMITED PARTNERSHIP WITH A LIVING TRUST FOR ESTATE PLANNING PURPOSES

A Living Trust can be a limited partner in a Family Limited Partnership. This allows for the advantages of a Living Trust to dovetail with the advantages of a Family Limited Partnership to create a master estate plan. This master estate plan accomplishes the estate planning objectives of passing the family business to the next generation with the least amount of estate tax; to provide a plan that can be funded with life insurance to pay estate taxes; to protect and preserve the estate from frivolous or predatory litigation, and to substantially reduce the hardship and cost of settling the estate of a deceased spouse.

Both the irrevocable life insurance trust and the Family Limited Partnership are excellent vehicles to provide for total or partial estate tax exclusion of insurance proceeds. However, the Family Limited Partnership provides the possibility that the insured retain some measure of control while providing greater flexibility than an irrevocable trust.

IRREVOCABLE LIFE INSURANCE TRUST

To assure that life insurance proceeds are excluded from the insured's taxable estate, the insured must relinquish virtually all control over the policies and the trust assets.

FAMILY LIMITED PARTNERSHIP

The insured, as insured does not possess incidence of ownership over the policies. The insured, as general partner, has management control over all partnership assets, which include the life insurance policies. The insured can possess as little as 1 percent partnership interest and still serve as general or managing partner. Thereby, the insured may retain some measure of control without causing inclusion of the entire amount of life insurance proceeds in his or her taxable estate.

THE IRREVOCABLE LIFE INSURANCE TRUST

The irrevocable life insurance trust is just that: irrevocable. The grantor cannot alter, amend or change the terms of the trust. This restriction makes the trust a rather inflexible document.

THE FAMILY LIMITED PARTNERSHIP AGREEMENT

A partnership agreement is a contract and thereby amendable. Therefore, a partnership is inherently more flexible than a irrevocable trust.

A complete Family Limited Partnership includes the following documents:

                    Notice of gifts.

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