Starting a Partnership As a Family
Starting a business can be an exciting experience for anyone that decides to get involved. If a company has a strong foundation, and if it is properly managed, it can create lasting income for its owners and operators. It is common for members of a family to go into business together due to the fact that there is usually more trust and history between relatives. Families that are interested in starting a business may want to consider establishing their envisioned company as an FLP. This type of entity is an excellent option for protecting family assets and receiving tax breaks from the Internal Revenue Service or IRS, as it is most often referred to as.
What Is An FLP
FLP stands for Family Limited Partnership. It is an arrangement between relatives that want to combine their money to start a business. Members of a family that decide to register a company as a Family Limited Partnership will have the ability to purchase shares or units of the company. This will allow relatives to receive profits from the shares they own of the company. The amount of profit earned is directly attributed to the number of shares a family member holds. Generally, the more equity a person owns, the more money they earn from the business profits. The partnership agreement that is drafted upon registering the company will contain the details of how profits and shares are distributed, as well as information about what would happen if the partnership was dissolved. The family members that own the company will be responsible for arranging the exact details of the partnership agreement, as well as issuing shares and profits. An FLP functions just like a standard limited partnership. However, there are two types of partnership interests involved, examine the difference between the two below.
– Limited Partner: A limited partner of a Family Limited Partnership does not have control over the company’s investment decisions or daily operations. A benefit of being a limited partner is the reduced risk since this type of partner has little or no liability. Partner roles and responsibilities within the company are outlined in the partnership agreement that is drafted upon founding the company. It is common for a limited partner to be a child of the general partner or partner.
– General Partner: A general partner of an FLP is responsible for managing all company operations, finances, and investment decisions. They are also responsible for transferring equity and assets to their company’s limited partners. General partners have 100% liability over the company’s assets and affairs, which increases their financial risk significantly. Usually, parents are the general partners of a Family Limited Partnership.
Advantages Of A Family Limited Partnership
The advantages of establishing a company as a Family Limited Partnership include tax breaks, estate planning, limited partners, and various benefits from the structure of an FLP agreement. This type of business formation is most beneficial for parents that want to involve their children in their company while maintaining general control. Before founding a business, consider the following advantages of an FLP.
– Gift Tax Exclusion: General partners are able to transfer assets and have that transaction qualify for a gift tax exclusion. The exclusion allows a tax-free transfer of interests to take place between a general partner and a limited partner of an FLP. This is an excellent way for relatives, such as parents, to receive tax reductions while passing wealth on to the next generation of their families.
– Family Limited Partnership Estate And Tax Benefits: Another wonderful advantage of establishing an FLP is the considerably large amounts of money that partners can save on taxes. Since the ownership is split up between multiple relatives, the IRS offers a tax reduction. All future returns that are earned from an asset will not be included in the general partner’s estate. Instead, all future returns would remain in the FLP entity. If a general partner were to die, their estate would only include the original value of an asset, not the returns that were generated. As a point of reference, if a parent transferred an investment property valued at $200,000 to the FLP, then that original value is the only amount included in the parent’s estate. Even if that initial investment earned $400,000 in returns, the parent would only have to claim the original investment property value of $200,000 as part of their estate.
– Family Limited Partnership Agreement: General partners, often parents of an FLP entity, hold continuous control over the company’s finances, investments, and daily operations. They can create the FLP agreement and set any restrictions or requirements for asset transfers. General partners draft the formation and dissolution details and partnership provisions. They can also amend the partnership agreement at any time if they ever decide to add or remove restrictions or implement additional details.
– Creditors And Partners Are Limited: General partners of an FLP are the only people that can permit creditors to have access to company interests. In addition, creditors cannot force an FLC to make cash distributions. A Family Limited Partnership provides more asset protection than other partnership entities that families might consider. Limited partners have restrictions on company assets and operations, those restrictions are outlined in the partnership agreement that is drafted by the general partners.
Disadvantages Of A Family Limited Partnership
Though there are many benefits to this type of entity structure, there are some disadvantages that should be considered as well. Founding a company as a Family Limited Partnership can be an expensive, complex endeavor. There are restrictions on the types of assets that can be transferred, and the liability risk of general partners is higher than many other types of business ownership. Consider the disadvantages listed below for a further explanation.
– Asset Transfer Restrictions For An FLP: Personal assets of general and limited partners cannot be transferred to an FLP without the family risking the ability to qualify for the annual gift tax exclusion. Securities, investment properties, and assets alike are best suited for transfer to an FLP.
– General Partner Liability Risk: An FLP is a business, and with the increase of liability, the general partners of the company need to have the ability to properly manage it. General partners are 100% liable for all creditor claims and lawsuits potentially brought against the company. Limited partners are not susceptible to the liability of the business, but they also do not have the power to manage any company assets without permission from a general partner.
– Expensive And Tedious Process: Establishing a business as a Family Limited Partnership can be a complicated process. It is highly recommended that anyone interested in creating an FLP seek professional assistance. Tax experts, property evaluation agents, and estate planning attorneys are essential for a smooth setup and continued management of an FLP.
The Difference Between An FLP And Similar Entity Types
Every type of entity has various potential benefits for its founders. It is important to research any entity that may be of interest. Some of the most common types that families use include Family Limited Partnerships, Trusts, and Limited Liability Companies. There are notable differences between a Family Limited Partnership and other entity types that are similar.
– FLP Compared To An LLC: Estate planning is a prominent benefit of a Family Limited Partnership. Relatives that register their company as an FLP can also take advantage of the annual gift tax exclusion offered by the IRS. Forming a company as an LLC will not provide that cash-saving benefit. That tax break allows a general partner or partners, to transfer assets and interests to limited partners as they desire. The amount transferred must remain within the threshold of the annual gift tax exclusion. It is worth noting, married couples typically receive twice the amount of gift tax exclusion than individuals do. So having two parents involved as general partners will save even more money.
– FLP Compared To A Trust: A Trust is not a business, but a Family Limited Partnership is. One similarity between the two is the fact that both structures allow parents to transfer assets to their children. Family members that have registered a business as an FLP will earn profits from their company. The amount of profit earned depends on the number of shares the general or limited partner owns. If a limited partner wants to acquire more shares, they must contact a general partner to receive permission. This is due to the fact that general partners have complete control over company shares and other assets.
How To Form A Family Limited Partnership
The intended general partners of an FLP will need to draft a partnership agreement that outlines the business inception and dissolution details, as well as the limited partner restrictions and asset transfer provisions. There are professional companies, such as LLC Formations, that can assist relatives in the setup of a Family Limited Partnership. They simplify the process and ensure that the company is properly established. There can be a lot of paperwork required to ensure a company is abiding by state and federal laws, so it is best to have some professional help as guidance. As previously stated, general partners should also contact an estate planning attorney and property valuation expert to advise them throughout the process.
Choosing The Best Company To Assist With An FLP
Professional assistance from a reputable company will make the process of forming an FLP easier and less stressful for everyone involved. A company that can assist in the legal registration of a business should have industry experience and excellent customer service. LLC Formations is well-known for its ability to properly form companies for its clients while still providing personable customer service. Whether you want to launch your business today or simply learn more about the process and regulations involved, contact a team of professionals to make sure you are getting accurate information from a trusted source.
Founding a business involves many decisions that must be carefully considered before the company’s inception, and during its continuous management. Those decisions include choosing the best entity type, partners involved, and allocation of the appropriate assets. Family members that want to start a business together while protecting their assets should consider establishing their company as a Family Limited Partnership. An FLP has many advantages that can save families money annually. Those advantages include gift tax exclusion, general partner estate transfer, and controlled management of assets by limited partners and creditors. However, there are some disadvantages to forming a company as an FLP. Be sure to carefully analyze the benefits and drawbacks of each entity type to determine which one would be best for your family business. To learn more about Family Limited Partnerships or to get started establishing one, seek professional advice and assistance from a reputable company such as LLC Formations.