Family limited partnership

A Family Limited Partnership (FLP) is a legal entity that creates a shared ownership structure among family members, commonly used for estate planning, asset protection, and wealth transfer. An FLP consists of general partners (typically the parents) who manage the partnership and bear liability, and limited partners (typically children or other heirs) who are passive investors with no management authority and limited liability.

26 steps across 5 sections

1. How Flps Work

  • Formation: Parents (or senior generation) create the FLP under state law and contribute assets such as real estate, securities, business interests, or cash.
  • Ownership split: Parents typically retain a small general partnership interest (1-2%) and initially hold all limited partnership interests.
  • Gifting interests: Over time, parents gift limited partnership interests to children or trusts for their benefit, using annual gift tax exclusions ($19,000 per recipient in 2026) and/or lifetime gi...
  • Ongoing management: The general partner retains full control over investment decisions, distributions, and operations — even as ownership shifts to limited partners.
  • Distributions: The general partner decides when and how much income to distribute to partners (subject to partnership agreement terms).

2. Valuation Discounts

  • Lack of marketability discount (LOMD) Because FLP interests cannot be sold on the open market like public stock, they are worth less than their proportional share of underlying assets. Typical discount: 15-35%.
  • Lack of control discount (minority interest discount) Limited partners have no management control, further reducing the fair market value. Typical discount: 10-25%.
  • Combined discounts Together, these can reduce the taxable gift value by 25-40% below the proportional net asset value.

3. Estate Tax Benefits

  • Removes future appreciation Once interests are gifted, all future growth in value occurs outside the parents' taxable estate.
  • Leverages exemptions Discounts allow more wealth to pass within the lifetime gift tax exemption ($15 million per person in 2026, made permanent by the OBBBA).
  • Reduces gross estate The general partner interest remaining in the estate at death is typically only 1-2% of the FLP value.
  • Annual exclusion gifting Small fractional interests can be gifted annually to multiple family members, systematically shrinking the estate.

4. Setup Process

  • Consult an estate planning attorney and CPA experienced with FLPs.
  • Draft the partnership agreement defining roles, distribution policies, transfer restrictions, and dissolution terms.
  • File formation documents with the state (certificate of limited partnership).
  • Obtain an EIN from the IRS.
  • Fund the FLP by transferring assets (deed real estate, retitle accounts, assign business interests).
  • Obtain a qualified appraisal of the FLP interests.
  • Execute gifts of limited partnership interests (file Form 709 gift tax returns).
  • Maintain ongoing compliance: annual tax returns (Form 1065), partnership meetings, separate books and records.

5. Irs Scrutiny

  • Lack of legitimate business purpose An FLP must serve a purpose beyond merely reducing estate taxes (e.g., centralized management, asset protection, family governance). "Tax avoidance only" FLPs are routinely disallowed.
  • Deathbed FLPs Partnerships created shortly before death raise red flags. Courts have included FLP assets in the decedent's estate under IRC Section 2036 (retained life estate).
  • Commingling personal and partnership assets Using FLP funds for personal expenses destroys the entity's legitimacy.
  • Failure to observe formalities Missing partnership meetings, tax filings, or record-keeping undermines the FLP structure.
  • Excessive discounts The IRS may challenge discount levels exceeding 30-35% and require the taxpayer to justify them with credible appraisal methodology.
  • IRC Section 2036(a) If the IRS proves the grantor retained enjoyment of transferred assets, the entire FLP value may be pulled back into the estate.

Common Mistakes

  • Creating an FLP solely for tax savings
  • Failing to observe partnership formalities
  • Commingling personal and partnership funds
  • Waiting until a terminal diagnosis
  • Using inflated valuation discounts

Pro Tips

  • Start early
  • Document everything
  • Use an LLC as general partner
  • Get a qualified appraisal every time you gift interests
  • Consider a "built-in" distribution policy

Sources

Related Checklists