If you are one of the millions of people for whom owning a family business is part of the American dream, and you are planning to make that dream a reality, you have a number of difficult decision ahead of you before your business can officially get off the ground. One of the most important of those decisions is the type of legal entity you want for your company. If you are certain you wish to keep the business in the family, a Family Limited Partnership might be right for you. We will explain how a Family Limited Partnership might fit into your estate plan.
Choosing Your Business Structure
Starting a small business requires you to make several very important decisions that will directly impact the success of your business. One of the first decision you need to make involves choosing the right business entity for your new business. The type of entity you form will impact important aspects of your business, such as:
- Taxation – a corporation incurs “double taxation. It pays taxes separate and apart from any taxes owed by the shareholders for profits passed down to them – and then the shareholders pay taxes on profits they received whereas a partnership and sole proprietorship only pay “pass through” taxes on the profits passed through to the owners.
- Liability – the legal structure you pick will directly impact whether you are shielded from the debts and liabilities of the business.
- Management – the entity you chose will affect how the business is managed and your role in that management structure.
- Investment and growth – if you hope to grow the business in the future, you want to choose a structure that is the most attractive type of legal structure for investors.
Family Limited Partnership Basics
A Family Limited Partnership (FLP) is a specific type of limited partnership. A limited partnership is a partnership that has two different types of partners – general partners and limited partners. General partners control all management and investment decisions and bear all the liability for debts and other liabilities of the partnership. Limited partners cannot participate in the management of the limited partnership and have limited liability. Like all partnerships, the profits and losses of the business are passed through to the partners in proportion to their interest in the business. The partnership itself does not pay taxes. A family limited partnership is simply a limited partnership that is owned by family members. Typically, in an FLP the older members of the family contribute property, cash, or other assets to the business in exchange for a small general partner interest and a large limited partner interest. Over time, they then gift their limited partner interest to the younger members of the family. Eventually, the entire business is passed down to the next generation of partners.
Protecting Your Assets with a Family Limited Partnership
When a family business owner fails to plan ahead, it dramatically increases the likelihood that the business will fail to successfully transition to the next generation. One common cause of that failure is federal gift and estate taxes. When the business owner dies, all the business assets are subject to taxation because they remain part of his/her estate. All too often, assets necessary to the survival of the business must be liquidated just to cover the tax bill. By establishing a FLP, the majority (if not all) of the business assets are transferred to the next generation long before the death of the patriarch/matriarch.
Please download our FREE estate planning checklist. If you have additional questions or concerns about forming a Family Limited Partnership, contact us at the Northern California Center for Estate Planning & Elder Law by calling (916)-437-3500 or by filling out our online contact form.