THE REPORT:  The family limited partnership can be a very powerful estate planning tool with a broad range of different applications and uses.  Recently, this technique has received a great deal of notoriety with a flood of articles covering the topic.

THE COMMENT:  

A)      Administration.  The family limited partnership is a limited partnership agreement in which the partners are members of the same family. Typically, a family limited partnership will be formed by husband and wife and their children.  In such a case, one or both parents act as general partner and the parents and children are limited partners.  If the children are not issued limited partnership interests at the time the partnership is created, their parents may transfer limited partnership interests to them in the future. 

         In Illinois , a family limited partnership is created by filing a certificate of limited partnership with the Secretary of State in accordance with the Illinois Revised Uniform Limited Partnership Act (RULPA).  The operation of the family limited partnership is governed by the certificate of limited, a written partnership agreement and the provisions of RULPA.  The limited partnership agreement will set out the terms of the partnership including capital contributions, distributions of cash flow and the allocation of profits and losses.  The general partners have broad authority to manage and to conduct the operations of the partnership and may receive compensation from the partnership for those services.  The limited partners typically have limited voting and management rights.

      Like any other partnership, informational tax returns (e.g. IRS Form 1065) must be filed by the family limited partnership, even though all the income from the partnership is taxable to the partners.  The partnership itself should not be a tax paying entity. 

B)       Flexibility of a Family Limited Partnership.  Compared to an irrevocable trust which may not be amended, a limited partnership agreement is a flexible document. If all the partners agree, the partnership agreement may be amended or terminated. In contrast, an irrevocable trust generally may not be amended or terminated without court participation. A partnership may also be terminated without adverse tax consequence.  In contrast, there may be substantial tax consequences on the liquidation of a corporation or the transfer of assets from an irrevocable trust. 

C)   Advantages of a Family Limited Partnership.

1.        Consolidation of family assets into a partnership may provide significant cost savings in the operation and management of those assets. 

2.     A partnership may simplify annual gift giving by the senior family members.  Not only is it easier to make a gift of undivided interest in the partnership, but the transfer of a limited partnership interest can be discounted for gift and estate tax purposes.

3.     Family limited partnerships can protect family assets against future creditors.  Unless there has been a fraudulent conveyance of the partnership, a creditor may not reach the partnership assets.  While the creditor of a limited partner will not have any management rights in the limited partnership, the creditor may be entitled, should they obtain a judgment against the limited partner, to receive any distributions from the partnership that the limited partner would have been entitled to receive.  However, the partnership agreement can be drafted to provide that an involuntary transfer of partnership interest to a creditor is not a permissible transfer and cannot be made. Therefore, a properly drafted partnership agreement can allow the managing partner to retain the assets within the partnership and to allocate the judgment creditor of a limited partner a pro rata share of the partnership income during that year, thereby causing the creditor to pay tax on income that it did not receive. 

        In January, 2006, Illinois law was amended to allow the creation of a Limited Liability Limited Partnership or LLLP.  An LLLP provides increased creditor protection to the limited partners and the general partners.  Prior to this change in the law, many limited partnerships had a corporate general partner to provide creditor protection to the general partners.  This additional step is not necessary in an LLLP. 

4.         The family partnership agreement can provide greater flexibility in operations and investment authority since management is controlled by the general partners, thereby avoiding family disputes because all family members will not have the control over the assets involved.

THE BOTTOM LINE

        A family partnership can be used in a number of situations which will enable an older generation family member to save estate and gift taxes and to accomplish other estate planning goals.  The drafting of a limited partnership agreement is a complex task, but a properly tailored family limited partnership can facilitate the management of family, achieve specific goals and provide a significant benefit to family members.