Family LLC or Family Limited Partnership?
Which Entity is Right for My Family?Every family is different. There is no right choice for everyone. In fact, the best choice might be neither option. In order to make sure these entities will work for your situation, it’s best to seek expert legal advice.
On this page, our estate planning and business attorney explains what FLLCs and FLPs are, what they’re used for, and the pros and cons of each entity type.
What is a Family Limited Partnership (FLP) and How Does It Work?
An FLP is a choice of business organization. It differs from a “normal” limited partnership in that the ownership is restricted to family members via the partnership agreement. As such, no outsiders may hold an ownership interest in an FLP. In all other respects, it is governed no differently from a limited partnership. The FLP is made up of the general partner(s) and limited partners.
Who Controls the Family Limited Partnership (FLP)?
The Family Limited Partnership has two classes of ownership, general partners and limited partners. The general partners control the business and make all the decisions related to the business. The limited partners on the other hand have no part in the decision making process. Both partners own their respective percentages or shares of the business, but the limited partners do not have voting rights.
The general partner can be a single person, group of people, or a corporation formed to control the business. The limited partnership is advantageous in this structure because generally speaking, it is easier to run the business when you have a single person who makes the decisions rather than a committee.
The limited interests may go to the children, trusts for the children, or to an entity(ies). Because the limited interests have no decision making power, but do own ownership, the family limited partnership gives a testator the ability to transfer assets during life, without giving up control.
What are the Other Benefits of an FLP?
Aside from lifetime gifting while retaining control, the other major benefits of an FLP are valuation reductions, liability protection, and tax burden shifting.
Because the limited partnership interest has no control or voting rights over the business, a market savvy third party will not pay the full book value for an interest with no voting rights. As such, you are able to achieve a valuation discount for gifted limited partner shares. This is a powerful tool for wealth transfer planning and estate tax minimization.
In addition to valuation discounting, an FLP shields its limited partners from the liabilities of the business. It does not shield the general partners, but a corporation or LLC may be formed to be the general partner.
The final big benefit from forming an FLP is the ability to shift the tax burden amongst the partners. The income tax burden is passed through proportionately to the partners even if the income is retained within the partnership. Through the use of limited partner shares, the founder may retain a minority interest, but all the control.
What Type of Assets Go Into an FLP?
In order to pass the IRS’s smell test, the FLP should have a business purpose. In other words, it should be created to generate wealth. As such, the family home where everyone lives is a poor asset to place in an FLP. Contrast that with rental real estate, stocks & bonds, the family business, a farm, or any other income generating asset. Collectibles may be a good asset to place in an FLP, but it’s a case by case determination. Speak with an attorney to find out if your collectibles are a good fit for inclusion in an FLP or how to structure an FLP to hold valuable collectibles or works of art.
Do I Need an FLP?
If you reasonably believe your estate may exceed the lifetime exemption and want to minimize your estate taxes, an FLP is a powerful tool to transfer assets while alive, and at a discounted valuation. Contact us to find out if your family can benefit from forming a family limited partnership.
What is a Family LLC?
Similar to a Family Limited Partnership, a Family LLC is simply an LLC whose membership is limited to blood relatives or spouses of blood relatives via limitations found in the operating agreement. By limiting the membership to only family members, you can achieve testamentary goals such as ensuring your family benefits from ownership of the family business. In other words, it allows you to “keep it in the family.”
The Family LLC differs from a regular LLC in that the ownership interests are restricted. In other words, if a non-family member were to acquire a membership interest in a Family LLC, they would have to divest themselves of the interest per the operating agreement. There are several ways to structure the limitation on membership interest, but the common thread throughout is the restriction of only family members having ownership in the company.
How Do I Form a Family LLC?
A Family LLC requires two main components: an operating agreement and articles of organization. The articles of organization is a fairly straightforward document which lists basic facts about the current membership, location, and other basic information. Some states have standard articles of organization which you may be able to use.
The more important document which creates the Family LLC is the operating agreement. This agreement lays out the terms and conditions of membership, rules, and everything else about running the organization. Once executed, the document forms the governing document of the organization. This is the document which restricts membership interests to family members. Without it, the organization would just be a regular LLC.
Due to the complexities and myriad clauses available, it is wise to seek expert legal advice when drafting or reviewing a Family LLC’s operating agreement.
What are the Pros and Cons of a Family LLC?
Pros:
- Limited liability for all members.
- Restrictions on transfer rights & ownership.
- Easier transfer to the next generation.
- Pass through entity for income tax purposes.
- Valuation discounts for limited members.
- Founders may maintain control via a two tier share system.
- Greater flexibility to minimize federal gift and estate taxes.
Cons:
- The FLLC must meet IRS requirements in order to qualify as an FLLC. In other words, there must be a nominal business purpose. The FLLC cannot be formed merely to avoid paying taxes.
- The FLLC cannot hold personal assets with no business purpose.
- The limited members will not receive a stepped up basis.
- An FLLC is not the best way to transfer assets to minors.
- An LLC may require additional fees and yearly meetings depending on the state.
What is the Difference Between an FLLC and an FLP?
The differences between the two entity structures are the same as for a limited partnership and a limited liability company. Both are governed by governing documents and state laws. Both offer limited liability for the owners. Both offer a two tiered ownership structure where the founders may retain control while sharing ownership with other family members.
The FLP offers no liability protections for its general partners, whereas the FLLC does. The LLC offers liability protection in a similar manner as a corporation. So long as the members treat the business as a separate business, creditors will not be able to pierce the corporate veil and reach personal assets.
Another difference between the two is the ability of all members of an LLC to exercise managerial control. In a limited partnership, the limited partners cannot have managerial control, but in an FLLC, the members can choose to be member managed as opposed to manager managed, however it’s usually preferable to retain the manager managed structure.
The final difference between the two comes down to state laws. A partnership is fairly universal across the United States as it was recognized under the common law. By contrast, an LLC is a modern creation governed by each state’s statutes.
FLLC or FLP: Which Entity is Right for Me?
Every family is different. There is no right choice for everyone. In fact, the best choice might be neither option. In order to make sure these entities will work for your situation, it’s best to seek expert legal advice.
