A family limited partnership (FLP) is a limited partnership where partners are primarily related. The
creator can name themselves as general partner and retain full control regardless of the number of
additional partners. If John wishes to transfer part ownership of his business to his two adult
children, Cindy, and Luke, an FLP will allow him to retain managerial control over the company while
distributing family assets and providing protection from creditors (Raub & Belveder, N.D.). CFR
§20.2031-1(b) assesses the valuation of property in general includible in a decedent’s gross estate as
the fair market value at the time of death or the alternate valuation method under IRC §2032. CFR
§20.2031-3 values interests held in a business as the net among a willing purchaser would pay to a
willing seller, determined based on all relevant factors including a fair appraisal and demonstrated
earning capacity. This section allows for partnerships and closely held corporations to take
advantage of valuation discounts as shares convey no control and are relatively illiquid. The lack of
marketability, lack of control, and lack of liquidity reduce the assets’ value for gift tax purposes
during the decedent’s life and estate taxes following death. In addition, John can begin gifting up to
$17,000 (for 2023 under IRC §2503(b)) in limited partnership interest to Cindy and Luke through
taking advantage of the annual exclusion amount. Further gifting of interest would be valued at the
proportional FMV of the transfer less discounts attributed to lack of marketability, lack of control
and lack of interest.
Despite this, special valuation rules apply to transfers to members of family of certain interests in
corporations and partnerships under IRC §2701 and the use of discounts to the valuation of business
assets are susceptible to scrutiny. Any discounts applied to the valuation of an estate must be
supported through appraisals and may be subjective. As supported by IRS Revenue Ruling 59-60 the
valuator must consider all relevant facts, elements of common sense, informed judgement, and
applying reasonable weight to their significance (IRS, N.D.). Inaccurate valuations may be penalized
for a deficiency in taxes payable, and may trigger legal disputes with the IRS.
CFR §20.2031-1(b)
CFR §20.2031-3
IRC §2032
IRC §2503(b)
IRC §2701
IRS. (N.D.). IRS Revenue Ruling 59-60. Retrieved from
https://www.pvfllc.com/files/IRS_Revenue_Ruling_59-60.pdf
Raub, B., Belvedere, M. (N.D.). New Data on Family Limited Partnerships Reported on Estate Tax
Returns. Retrieved from https://www.irs.gov/pub/irs-soi/11pwcompench2cfam.pdf
The best partnership that John should convert his sole proprietorship into is a limited partnership.
We can even take it a step further and say that they create a family limited partnership (FLP). In this
type of partnerships, the general partner oversees the business and its operations. In our case, John
would be general partner. The other remaining partners are called limited partners which would be
Cindy and Luke and they would have little to no involvement in the management of the business.
Since John is the general partner, he would be liable for all the company's debts and financial
obligations. Under US code section 721 there would be no gain or loss on John's behalf since the
transfer to his kids is in exchange for interest in the partnership.
To structure the transfer of the business to Cindy and Luke, I would make sure that their interests
are non-controlling interests. IF this is put in place, any transfer would be given a discount. There is
also a second discount that could be given, and this is because "there is no ready market for the sale
of FLP limited interests." (Rubenstein, 2013) These discounts have been scrutinized by the IRS
because they can range between 25-40%. Any penalties for undervaluation will come from code
section 6662(a). This code section states that "there shall be added to the tax an amount equal to
20% or the portion of the underpayment to which this section applies. (26 U.S. Code § 6662)
Sources:
https://www.assetlawyer.com/family-limited-partnerships-
discounting/#:~:text=Family%20limited%20partnerships%20(FLPs)%20reduce,in%20the%20FLP%20is
%20discounted.
26 U.S. Code § 6662
Code Section 721
https://www.investopedia.com/terms/l/limitedpartnership.asp
