Why We Don't Recommend FLPs (most of the time)

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Friday, February 23, 2024

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Why We Don't Recommend Family Limited Partnerships

(most of the time)

Limited Family Partnerships (FLPs) have become an increasingly popular legal structure for family-owned businesses in recent years. This is because FLPs offer numerous benefits such as limited liability protection, tax benefits, business continuity, and flexibility in terms of ownership and management. However, like any other business structure, FLPs also have their drawbacks. In this article, we will explore the benefits and drawbacks of FLPs to help you make an informed decision about whether this type of partnership is the right choice for your family-owned business.

Benefits:

1. Limited liability protection for the limited partners: In an FLP, the limited partners are not personally liable for the debts and obligations of the business. This means that their personal assets are protected in case the business faces any legal or financial issues. This benefit is particularly important for family members who want to invest in the business but do not want to risk losing their personal assets.

2. Tax benefits for partners: FLPs are pass-through entities, which means that the income generated by the partnership is not subject to corporate tax but is instead passed through to the partners and taxed at their personal tax rate. This can result in significant tax savings for the partners, especially if they are in a higher tax bracket.

3. Business continuity in case of a partner’s death or departure: The partnership agreement can specify how the business will be managed and how the assets will be distributed in case of a partner’s death or departure. This can help ensure the smooth operation of the business and prevent any disputes among family members.

4. Flexibility in terms of ownership and management: FLPs offer flexibility in terms of ownership and management. The general partner can manage the business and make all the decisions, while the limited partners can be passive investors who have no involvement in the day-to-day operations of the business. This allows family members to invest in a business without having to worry about the management and operations.

5. FLPs and estate planning. An FLP can help reduce estate taxes and protect assets from creditors. By transferring assets to an FLP, family members can reduce the value of their estate and minimize estate taxes. Assets held in an FLP are protected from creditors, which can provide additional security for family members.

6. Family unity. An FLP can also provide an opportunity for family members to work together and build a legacy. Working together towards a common goal can strengthen family bonds and provide a sense of pride and accomplishment. Additionally, a successful family business can provide financial stability and security for future generations.

Drawbacks:

1. Limited control for limited partners: In an FLP, the limited partners have limited control over the business, while the general partner has the authority to make all the decisions and manage the business. This can be a source of conflict among family members, particularly if there are disagreements regarding the direction of the business.

2. Unlimited liability for the general partner: The general partner assumes unlimited liability for the business, meaning that if the business faces any legal or financial issues, the general partner’s personal assets are at risk. This can be a significant risk for family members who want to manage the business and assume the responsibilities of the general partner.

3. Complexity in setting up and managing the partnership: Setting up and managing an FLP can be complex and require the assistance of a lawyer or accountant. Additionally, the partnership must comply with state and federal regulations.

4. Potential challenges in terms of family dynamics: Business disputes can spill over into family relationships and cause tension among family members. Additionally, if the business is not performing well, it can cause financial stress for family members who have invested in the business.

5. General partner risks. If the general partner makes poor decisions or mismanages the business, it can have significant financial consequences. Additionally, disputes among family members can be difficult to resolve and can lead to long-lasting family conflicts.

6. Succession Planning. While FLPs provide essential estate planning features, the entity itself doesn't automatically create a succession plan. It is essential for you to create your own plan and put it in place for passing on the management of the business to the next generation. This can be complicated in an FLP, as the partnership agreement must be updated to reflect any changes in management or ownership.

State And Federal Regulations

FLPs are subject to various state and federal regulations. Each state has its own laws regarding the formation and operation of partnerships, and it is important to comply with these laws to avoid legal issues. Additionally, FLPs must comply with federal tax laws, including filing tax returns and paying taxes on time. Failure to comply with state and federal regulations can result in fines, penalties, and legal disputes. It is important to work with a lawyer or accountant to ensure that your FLP is in compliance with all applicable laws and regulations.

Conclusion

FLPs can provide many benefits for families who want to own and operate a business together. However, it is important to carefully consider the benefits and drawbacks and seek professional advice before deciding on this structure. With proper planning and management, an FLP can be a successful and rewarding way for families to work together towards a common goal and build a lasting legacy.

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