Business Formation Strategy: Family Limited Partnerships

Mar 16, 2021
Business Structure

One of the most difficult aspects of setting up a new business is choosing what kind of business to form. Commonly, new business partners are choosing between limited liability companies, S corporations and C corporations. There is no magic formula: which one is right for any business depends on a variety of factors.

However, family-owned businesses also have the option to form a company under a different designation: the family limited partnership.

What makes the family limited partnership different? 

At its most basic, the family limited partnership is a company that two or more legally-related family members own. The family limited partnership retains and protects that family's business interests, publicly traded and privately held securities or any other assets. The reason why this entity exists is to help provide creditor protection for the owners; while also reducing estate and gift taxes.

With the family limited partnership, two separate classes of owners exist. The first class of owners are “general partners.” These entities are the ones responsible for the daily management of the company and all of its assets. Traditionally, the “general partners” would be the business-owning parents themselves, or a limited liability company that represents the parents, assuming that the parents own an LLC to shield them from operational risks.

The second class owners are the limited partners. The limited partners have an economic interest in the business entity, but have no ability to control or otherwise influence the operation of the family limited partnership. Usually, limited partners do not even have the ability to sell their interest in the company, unless they sell it to another family member. Most of the time, limited partners are the children or grandchildren of the parents or grandparents that own the business.

What does a family limited partnership do for our business? 

Essentially, the family limited partnership allows the “active” owners (the general partners) to donate and gift assets to the “passive” owners (the limited partners) over time. Often, gifting portions of your estate through a family limited partnership to limited partners while you are still alive will save a lot of money on estate taxes, for example.

Family limited partnerships also allow you a great deal of flexibility. For instance, it is not uncommon for the parents to create the partnership before realizing if their first-born child is fit to inherit the business as the owner or not. You can take your time determining who will “inherit” the role of general partner. In some cases you may be able to pass it off to a son, daughter, or grandchild who has business aplomb. If not, you can decide that a third-party entity is better off managing the company in your retirement.

Keep in mind that a family limited partnership is still a partnership: you will need to have regular meetings with formal minutes. Partnerships are pass-through entities, meaning that the limited partners must pay taxes on whatever income they get through the partnership.

Overall, family limited partnerships are powerful and flexible estate-planning tools for business-owning families. Contact us today at AmeriEstate to learn more about how they can work for you.