Family Limited Partnerships (FLP) or Limited Liability Companies (FLLC) are most suitable for individuals who have a business, real estate, a farm or ranch, or investments and have sound business reasons to own and operate such assets in the form of a business entity. Properly used, FLPs and FLLCs can be of emmense benefit in directing the management of the business or investments, providing a procedure for the resolution of disputes, managing cash flow, providing an element of asset protection, and reducing estate tax by transferring interests in the entity to heirs.
The following hypothetical illustrates the use of a FLLC:
A couple owns an apartment complex worth $3,000,000. They have three children and would like to teach them how to manage the complex, and perhaps provide them with some cash flow. They would also like to reduce their estate by making gifts to the children. They give, say 10%, to each of the children, or to an irrevocable trust for the benefit of each child.
As the children develop, the couple intend to have them become more involved in management. They decide to use the FLLC because this entity allows for the division of ownership and management. A Limited Liability Company is managed by a Manager whereas a Limited Partnership is managed by a General Partner. The couple decides that there are to be three Managers, which are to be both of them and the oldest son (who is currently involved in the operations of the complex). The fact that the oldest son is a manager does not give him any additional percentage interest in the business, but allows him a voice in the management and, perhaps, compensation for his services. As the couple age and the other children become more involved, the management structure can be easily altered to fit their needs.
The couple’s 10% gift to each child is of the business interest. It is not a gift of cash or of the underlying apartment complex. This 10% LLC interest is not marketable, a child is not likely to find a buyer for a small percentage of a family business. In addition, the child or the trustee of the irrevocable trust for the benefit of the child has limited voting rights. The lack of marketability and control for the 10% interest reduces it’s value to a hypothetical buyer. This “discount” in value is appealing because more can be gifted tax free. See the above discussion on estate tax and gifting.
It is oftentimes advisable to have the gift held by an irrevocable trust for the child rather than by the child individually. This is very important if the child is a minor or otherwise unable to manage the asset but also provides the child with protection against law suits and failed marriages.
FLPs and FLLCs are excellent tools but are complex and should only be organized by an attorney very familiar with the technique and the income, estate and gift tax effect of the formation and operation of the entity and gift of entity interests.