Limited partnerships have been widely used in the context of estate planning for about the past 30 years. Family limited partnerships are attractive primarily for three reasons:
(1) Creditor protection
(2) Valuation discounts on gifts of limited partnership interest
(3) ability to maintain control
Gifts of interests in the entity will allow you to maintain more control over the underlying assets than will outright gifts of interests in the company or outright gifts of other assets to your family members. This is because you will control the limited partnership by controlling the general partner of the limited partnership. In this way you will have a measure of control over the assets held in the entity, regardless of your ownership percentage in the entity. Your family members (or trusts for their benefit), if you gift or sell interests to them, will be limited partners in the limited partnership, which will entitle them, generally, only to economic benefits and not to control the entity.
A summary list of what generally are considered to be the advantages of a limited partnership is as follows:
A. Limited partnerships presently are not subject to Texas margin tax if they qualify as a “passive entity;”
B. Operational income is not subject to federal corporate tax (i.e. flow through entity);
C. General partner or manager maintains control;
D. Valuation discounts of interests gifted;
E. Creditor protection through restrictions on transfer;
F. Simplifies annual gifting;
G. Consolidates assets for efficiency; and
H. Encourages communication about family business and financial matters.
Gifts to your family members of interests in the entity can be done in small amounts (such as $15,000 per donor per recipient per year). Alternatively, you could consider one or more larger gifts to your family members (or to trusts for their benefit) to use all or substantially all of your gift tax free amount (presently up to $11.7 million for each of you in 2021) while you are alive. This transfers future appreciation to the family members and minimizes the cost and hassle of gift giving since frequent appraisal updates would not be needed, as is the case with smaller annual gifts. Distributions from the entity typically are made in accordance with percentage ownership interests, so a large gift to your family members (or to trusts for their benefit) will mean that they will share proportionately in the net income from the entity. Each owner also bears the income tax burden attributable to his or her proportionate share of the limited partnership. For this reason the general partner may want to distribute to each owner at least enough to pay the income tax each owner will owe on his or her proportionate share of the income of the entity.
If, at your death you own assets outright, the full value of your interest in those assets would be part of the taxable estate. But if the same assets are held by a limited partnership, the value of the interest in the entity, rather than the assets owned by the limited partnership, is subject to tax. The interest in the limited partnership may have a lower value than the corresponding interest in the assets because the value of the interest in the limited partnership can be discounted (under current law) for lack of liquidity, lack of marketability, and lack of control. With the applicable discounts, the value of an interest in the entity could be 80% or less of the value of the underlying assets. Thus, if the value of the underlying assets owned by the entity is $1 million, the value of the interests in the entity could be only $800,000. Assuming the top estate tax rate applicable in 2021 of 40%, this translates into estate tax savings of some $80,000. An appraiser will provide the appropriate value of the interests, including any discounts.
The benefits of a limited partnership would be even greater if you make gifts over the years of interests to your family members. The same discounts discussed above may apply to the value of gifts of limited partnership interests, and you therefore may be able to maximize annual exclusion giving as well as use of your gift tax free amount. For example, if you decide to make annual exclusion gifts to your family members, you each could give assets worth $15,000 to each family member. If the same assets were held in a limited liability entity, you could give limited partnership interests worth $15,000, which would correspond to assets worth some $18,752 (assuming a 20% discount). Again, you would need an appraisal to support the value of the gift. If you do decide to make gifts to your family members, you will still retain a measure of influence over the limited partnership (and hence control of the assets owned by the entity) due to your roles as managers of the general partner.
The scope of control you can retain over the entity and still receive the benefits of a discounted value for gift tax and estate tax purposes presently is in flux. If and when you do want to make gifts of such interests, we can consider the structure of the entity in light of the law as it then exists.