Tax-Efficient Asset Management--A Basis for Partnership With Your Heirs As a framework for managing a personal investment portfolio, a family limited partnership (FLP) can provide many tangible benefits. An FLP treats the control of assets and the income they generate as separate items that can be assigned to different people. This can allow family members to share the administrative burdens and costs of portfolio management while focusing cash flow on one or two individuals. Also, by dividing the duties and benefits, you can set the stage for discounting the value of the assets in gift tax and estate tax accounting. This may create significant opportunities for tax management. FLPs Defined An FLP is a form of corporate ownership structure in which one or several stockholders serve as general partners who exercise management control over all investments held by the partnership. The remaining stockholders--the limited partners--are restricted to passive roles in investment management and control, even though the limited partners may receive the lion's share of any income produced by the assets in the FLP. Limited partners generally cannot sell or redeem their FLP shares without general partner approval. A limited partnership share may be discounted due to the lack of managerial authority over the underlying assets. FLP structures may be used for virtually any asset--diversified stock and bond portfolios, real estate or shares in a family business, among others. Variations on a Theme One common FLP structure involves several family members pooling their personal assets and agreeing to put those assets under common management. In this scenario, the dominant contributor becomes the general partner and the minority contributors become the limited partners. There is no taxable gift event if the partnership units are directly proportional to the market values of each partner's individual contributions. However, if the limited partners are assigned units representing a disproportionate share of the pooled assets, there may be gift tax exposure for the excess. In that event, the value of the gift may be discounted due to the limited partners' lack of control over the underlying assets. Another FLP structure involves a single contributor who places assets into an FLP, retaining a majority of the benefits of ownership but accepting only a limited partner's role in management. In this scenario, the general partner's authority is gifted with a small share of the partnership interest to an intended heir. The value of the partnership assets in the gift may be discounted because the general partner has only a small portion of the partnership equity and typically receives little direct financial benefit, even though the general partner directs dividend payments and investment policy. A Liability Buffer Any FLP structure creates a liability shield similar to other forms of corporate ownership. In general, financial claims against any business assets held in an FLP cannot be collected from the partners' personal assets. In addition, any personal liability claim against a partner typically cannot be extended to the FLP itself, although creditors may be able to seize that partner's share of any distributions or dividends. In some states, assets in an FLP may be insulated from claims in divorce proceedings. Considerations for Creating and Managing an FLP The most effective FLPs tend to be those created with valid business reasons--that is, with reasons other than simple tax management in mind. Such reasons may include a desire to set a framework for asset management and administration, or to create a financial apprenticeship structure for your children and other heirs. In addition, if you own significant investment property in another state, an FLP may eliminate the need for probate in that state as well as your home state. Experts often remind partners in FLPs that their partnership should operate just as any other business corporation would--otherwise the partners could lose access to many of the tax and estate planning benefits that made the structure attractive in the first place. For example, the partners in an FLP should maintain a clear paper trail showing that they carried out all of the duties agreed to in the partnership's agreement, which is essentially the equivalent of a corporate charter and bylaws. Putting appropriate financial management and control measures in place may prove to be vital to the viability of the FLP. For example, the FLP should have its own bank accounts to manage all income and expenditures related to FLP assets. And of course, while cash belonging to the partnership can be distributed, those distributions should be in the same proportions as the partnership interests. The IRS has challenged some FLPs and won by proving that general partners received excessive distributions and that the one-sidedness showed there had been no genuine transfer out of the estate. As with other business structures, an FLP should not be used to directly fund personal expenditures of any sort. This article was prepared by McGraw-Hill Financial Communications and is not intended to provide specific investment advice or recommendations for any individual. Consult your financial advisor, or me, if you have any questions. Because of the possibility of human or mechanical error by McGraw-Hill Financial Communications or its sources, neither McGraw-Hill Financial Communications nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall McGraw-Hill Financial Communications be liable for any indirect, special or consequential damages in connection with subscribers' or others' use of the content. | 
