FAQ's

Limited Partnerships

What is a "limited partnership?"

A limited partnership is a form of business entity that consists of at least one general partner and one limited partner. There are no limitations on either, thus the general partner may be an individual, a corporation, a LLC or general partnership. The limited partners, in turn, may also be individuals, corporations, LLCs or other limited partnership(s). The general partner(s) manage the business and are liable for all debts and obligations of the partnership. A general partner may make contributions to the limited partnership and share in the profits, losses, and distributions of the limited partnership both as a general partner and as a limited partner. The limited partners do not participate in the management of the limited partnership business and their liability is generally limited to the amount contributed to the partnership.

Limited partnerships are governed by ORS Chapter 70 that provides "default" provisions if the partners have not addressed the issues under a written partnership agreement. Limited partnerships organized under Oregon law are "domestic" limited partnerships. Thos formed under the laws of other states, but transacting business in Oregon, are "foreign" limited partnerships.

To form a limited partnership, an original certificate of limited partnership is executed and submitted for filing to the Secretary of State. The name of the limited partnership must contain (without abbreviation) the words "limited partnership."
What is a family limited partnership?
(a) General Information. Generally speaking, a family limited partnership ("FLP") is substantially similar to the typical limited partnership that has been formed for business purposes. There is a general partner that is most often a newly formed business corporation or limited liability company and multiple limited partners. Although individuals can be the general partner, most clients want the limited liability offered by having a corporation or limited liability company serve as the general partner since under state law the general partner is responsible for the debts of the limited partnership. The limited partners can be individual family members or in some cases, one or more irrevocable trusts for the benefit of children and/or grandchildren. Typically, the parents own the great majority of the partnership interests upon formation of the FLP and subsequently gift interests to their children and/or grandchildren using the annual exclusion from gift tax or some portion of their "unified credit" (now called "applicable exclusion" amount) to offset gift tax on larger gifts. In some cases however, the children may already own interests in a family owned business or real estate in which case they will contribute "their" interests in such assets to the FLP in exchange for their initial interests in the FLP. Thus, the primary difference between a regular "business" limited partnership and a FLP is that most (if not all) of the shareholders of the general partner (or members in the case of a limited liability company) and the limited partners will be family members.

The general partner manages the FLP’s business affairs and assets and in turn, is entitled to a management fee for providing these services. This management fee may be used to pay reasonable compensation to the officers and/or employees of the general partner. Generally, the parents will own all the stock and serve as the officers and directors of the corporate general partner. In many cases the clients (after consultation with their CPA) will decide to make the so-called "S-corporation" election for the general partner such that there will only be a single level income tax on distributions and/or liquidation of the general partner’s assets. The stock of the general partner can be gifted over time or left to one or more children under the wills of the parents depending on the clients’ business succession or overall estate plan. For example, if the FLP owns the stock of an operating business, in many cases, one or more (but not all) of the children are active in the family business and the parents will want the children who are "active" in the business to also retain control of the general partner. Under Oregon law, the limited partners must not participate in "management" of the FLP in order to preserve limited liability. In addition, the FLP agreement can function as a form of "buy-sell" agreement whereby transfers of limited partnership interests to non-family members are restricted unless first offered to the FLP and/or other partners.

(b) Formation and Gifting Programs. Both the general partner and the FLP are organized under state law in the jurisdiction where the partnership will conduct business and/or own property. Typically, the parents transfer their interest in various properties such as real estate, stock, mutual funds, etc. to the FLP in exchange for FLP interests or "units." Alternatively, family members can contribute their interests in property that is already jointly owned to the FLP in exchange for their interests. The general partner will also own some percentage of the capital and profits of the FLP; as little as 1% is permissible. Both the general partner and the FLP will have their own taxpayer identification numbers and separate bank accounts. It is extremely important to observe the formalities regarding separation of business and personal accounts. For example, the FLP account may not be used to pay personal expenses of partners.

In order to use the FLP as a gifting vehicle, the parents gift "units" of FLP interest to their children and/or grandchildren using their annual exclusion from gift tax ($12,000 per donee, or $24,000 if the parents elect "gift-splitting"). Gifts to grandchildren can be made outright (if the grandchild is over the age of majority) or to a parent or custodian under the applicable state Uniform Gifts [Transfers] to Minors Act. Alternatively, the parents can create an irrevocable trust for the benefit of all grandchildren to be used in providing funds for their educations. This educational trust, in turn, is a limited partner of the FLP. Direct or indirect gifts to grandchildren may be subject to the generation-skipping transfer tax ("GST tax"). Clients are advised to seek further information on the possible application of the GST tax from their tax advisor since they may wish to use some portion of their GST tax credit by filing a gift tax return reporting the gifts to grandchildren. Under the new (2001) tax laws, the GST tax will be on the same schedule for reduction and repeal as the phase-out of the estate tax.

Starting in 2002, the lifetime exclusion amount for gift tax purposes increases to $1 million. This exclusion is in addition to the annual exclusion. Unlike the gradual increase in the estate tax exclusion amount; however, the gift tax exclusion will remain at $1 million, with no further adjustments. The gift tax rate will be phased down but is not entirely eliminated. Initially, it is reduced to 50% and continues to drop together with the estate tax rate until the estate tax repeal in 2010. In 2010, the gift tax is not eliminated, rather it will be continue at the highest personal income tax rate applicable at that time (scheduled to be 35%) with the $1 million lifetime exemption continuing in effect.

As discussed below, a significant benefit from making gifts in the form of FLP interest or "units" rather than the underlying property, is that the FLP units are eligible for certain discounts which allow the annual exclusion to be leveraged. For example, if the total valuation discounts equal 40%, each parent can gift $15,400 worth of FLP units rather than $12,000 per year to each child and/or grandchild using the annual exclusion. The same leverage would apply in the case of gifts using some portion of the "applicable exclusion;" however, the discount used will need to be determined by an independent appraisal to support the gift tax return. Finally at the time of death of the donor "parent," the amount of his or her taxable estate will not include the FLP interests which had previously been gifted to children and/or grandchildren. Further, the value of the FLP interests still owned by the "parent" at the time of death, will be discounted for estate tax purposes based on the available discounts for minority interest and/or lack of marketability. Again, the level of discounts claimed must be supported by an appraisal.

Thus, a number of significant benefit exist for gifts of FLP interests:
1. The parents can retain complete control over gifted assets (now in the form of limited partnership units) through ownership of the general partner; and
2. The annual exclusion from gift tax and "unified credit" (applicable exclusion) can be leveraged through the use of appropriate valuation discounts.
(c) Reduction of Probate Expenses. Establishing a FLP can reduce probate expenses by consolidating assets owned in multiple states, such as real property, into two assets: (1) an interest in the FLP, and (2) shares of stock in the corporate general partner. In either case, for purposes of a probate proceeding, both the FLP interests and/or stock in the general partner will be treated as "intangible" property, which is probated in the decedent’s domicile. Since title to the assets would already have been transferred to the FLP during the decedent’s lifetime, using a FLP avoids the necessity of an ancillary probate to transfer title to real property located in other states. For example, if you acquire title to a vacation home in the name of the FLP, regardless of your domicile at the time of death, there would be no ancillary probate required for the out of state real property.

(d) Reduction of Taxable Estate. Perhaps the most significant advantage of the FLP is its effect on the valuation of a decedent’s taxable estate. As long as there remains a combined estate and gift tax, FLPs will be an effective way to take advantage of appropriate discounting - - and maximize the use of both the annual and lifetime gift tax exemptions. As a starting point, the tax laws require that a decedent include the fair market value of all property owned at the time of death in his or her gross taxable estate. However, there is no particular formula to be applied in determining the fair market value of such property. Nevertheless, it has long been recognized that the value of an estate asset will be adjusted to reflect a variety of special factors, such as a discount for lack of marketability and a discount for minority status, or lack of control in a closely held entity. Within fairly recent years, the Internal Revenue Service was forced to abandon its long-held position that ownership of interests in a closely held entity by family members must be aggregated such that the decedent is deemed to "control" the entity for purpose of valuation.

For example, in the typical FLP, the husband and wife will each own 49.5% or less of the FLP interests, and 50% or less of the stock of the corporate general partner. Their children, in turn, own the remainder of the FLP interests and perhaps a minority interest in the general partner. Under current law, the fair market value of the decedent’s interest in the FLP and the general partner should be discounted for lack of marketability and lack of control. The actual discount factor varies and is a factual issue that must be determined on a case-by-case basis with the taxpayer having the burden of proof on the issue if audited. Accordingly, the taxpayer should first obtain a reliable business appraisal before taking discounts for gift and estate tax purposes. Unsubstantiated discounts will be disallowed.

(e) The FLP as a Creditor Protection Tool. In times of economic uncertainty, individuals tend to focus on preserving the assets they already own. These assets of course remain subject to both known and unknown potential liabilities in the form of personal injury and malpractice suits or joint and several liabilities created by the death or bankruptcy of co-guarantors or other general partners.

The FLP vehicle is unique in that the limited partner’s creditors have no right to any property owned by the FLP even if the FLP has sufficient assets to pay off the obligation or judgment. Under most state’s Uniform Limited Partnership Acts, the rights of a judgment creditor are limited to obtaining a so-called "charging order" against a debtor’s interest in his or her FLP interest. A charging order entitles the judgment creditor to receive any distributions of cash or property made to the debtor as a limited partner of the FLP. The charging order does not, however, give the creditor the right to vote the interest of the partner or the right to acquire the limited partner’s interest in the FLP. Without the ability to vote, the judgment creditor is unable to: (a) dissolve the FLP; (b) liquidate the FLP; (c) amend the FLP agreement; (d) remove the general partner, or (e) force income distributions to be made to the limited partners. Consequently, the parents, as officers and directors of the general partner, may well decide that is not in the best interests of the debtor limited partner to make distributions at that time, and therefore, there is nothing to distribute to the judgment creditor. In other words, since the timing and amounts of income distributions are within the discretion of the general partner pursuant to the partnership agreement, the creditor may be sent away "empty-handed." However that does not mean that the general partner is prevented from taking a management fee and continuing to pay reasonable salaries to any family members providing services to the FLP or the general partner.

Finally, since a charging order on a debtor’s interest in a FLP gives the judgment creditor the status of an "assignee" of a debtor limited partner, the judgment creditor becomes responsible for paying the debtor’s pro rata portion of income taxes due on allocable income from the FLP. Assuming the FLP has taxable income but no distributions are made to limited partners of either the total amount of the income or an amount necessary to pay any income taxes due on such income (this provision is stated under the partnership agreement), the judgment creditor may be forced to pay income taxes on income that was not received. In many cases, this result will be a severe detriment to any judgment creditor wishing to pursue the collection of a debt by means of going after the debtor’s FLP interest.

(f) Planning Opportunities Using a FLP. Through the organization and operation of a FLP, you can do the following:
1. Maintain the desired cash flow since a portion of income from FLP assets can flow to the general partner as management fees and in turn, be paid as reasonable compensation for services;
2. Make gifts of FLP interests to your children and/or grandchildren without giving up control of the underlying assets;
3. Minimize probate administration costs by avoiding ancillary probate(s) if real property is owned in other states;
4. Reduce the size of your taxable estate for federal estate and state inheritance tax purposes by: (a) implementing a gifting program using FLP interests, and (b) the creation of applicable valuation discounts for FLP interests owned at the time of death;
5. Preserve the underlying assets owned by the FLP from claims made by judgment creditors against individual limited partners; and
6. Leverage the use of the annual gift tax exclusion and "unified credit" (applicable exclusion) against estate tax with appropriate valuation discounts.