Family Limited Partnership (FLP): How to Gift Assets at a 30% IRS Discount
Family Limited Partnership (FLP): How to Gift Assets at a 30% IRS Discount
๐ WHO THIS IS FOR (Prerequisites)
- Required Profile: Ultra-High-Net-Worth Families (Estates > $27M Married) facing imminent Estate Taxes (40%).
- Primary Objective: Valuation Compression (Artificially lowering the tax value of assets before transferring them to heirs).
- Disqualifying Factor: Families with “Simple Assets” (Public Stocks/Cash only) or those unwilling to maintain strict corporate formalities.
โ ๏ธ STRATEGY ELIGIBILITY CHECK
An FLP is a legal entity, not just a bank account. The IRS attacks FLPs that lack “Legitimate Business Purpose.”
- โ๏ธ Asset Type: Works best with illiquid assets (Real Estate, Private Business, Art). Public stock portfolios are harder to discount aggressively.
- โ๏ธ Appraisal Requirement: You must hire a qualified appraiser to defend the discount (DLOM/DLOC). A “guess” will trigger an audit.
- โ๏ธ No Commingling: You generally cannot use FLP funds to pay for personal expenses (groceries, vacations). This pierces the corporate veil (Section 2036).
- โ๏ธ Timing: Do not set up an FLP on your deathbed. It looks like a tax dodge. It should be established years in advance.
*Warning: The “Powell” and “Strangi” court cases allow the IRS to ignore the FLP if the parent retains too much implied control or access to income.
EXECUTIVE SUMMARY
- The Concept: A $10M building is worth $10M. But a “10% Non-Voting Share” of a partnership that owns the building is not worth $1M. It’s worth less because you can’t sell it easily or control the building.
- The Strategy: Parents transfer assets into an FLP. They keep 1% General Partner (GP) interest (Control) and gift 99% Limited Partner (LP) interest to kids.
- The Discount: Because the LP shares have No Control and No Marketability, appraisers can discount their value by 25-40%.
- The Payoff: You transfer $10M of underlying wealth using only ~$6.5M of your Gift Tax Exemption. The remaining $3.5M vanishes from the tax system legally.
In the eyes of the IRS, “Price” is what a willing buyer pays a willing seller. No stranger would pay $1M for a $1M share they cannot sell or control. They would demand a discount. The FLP strategy simply formalizes this economic reality to reduce taxes. Source: ACTEC / J.P. Morgan Private Bank
- Asset: Commercial Real Estate Portfolio worth $10,000,000.
- Action: Gift 40% Limited Partner Interest to Children.
- Appraised Discount: 35% Combined (Lack of Control + Lack of Marketability).
- Tax Rate: 40% Federal Estate/Gift Tax Rate.
- Objective: Calculate “Phantom Savings” created by the discount.
Taxable Value Simulation ($4M Gift)
| Method | Underlying Asset Value | Reported Taxable Gift Value |
|---|---|---|
| Direct Gift (No FLP) | 4000000 | 4000000 |
| FLP Interest Gift (35% Discount) | 4000000 | 2600000 |
*Chart Note: The FLP structure allows you to transfer $4M of real wealth while only using $2.6M of your lifetime exemption. The $1.4M difference is “Tax-Free Air.” If taxed at 40%, this saves $560,000 in cash taxes.
Valuation Discount Matrix
*The math behind why a dollar is not worth a dollar.
| Discount Type | Economic Rationale | Typical Range |
|---|---|---|
| DLOC (Lack of Control) | Minority owners (LPs) cannot force a sale, declare dividends, or fire the manager. | 10% – 15% |
| DLOM (Lack of Marketability) | There is no public stock exchange for “Jones Family Partnership” shares. Selling requires finding a private buyer. | 20% – 30% |
| Total Combined Discount | Multiplicative effect of DLOC and DLOM. | 30% – 40% (Defensible via Appraisal) |
*Operational Note: Discounts are higher for real estate and operating businesses, and lower for portfolios consisting only of cash/marketable securities (because cash is easy to value).
Retaining the Reins:
- The Fear: “I don’t want my 25-year-old kid to sell the building.”
- The Solution: As the General Partner (GP), you retain 100% operational control. You decide when to sell, when to distribute cash, and how to invest.
- The Kid’s Role: The children (Limited Partners) have economic rights (equity) but zero voting rights regarding operations. It protects the assets from the kids’ bad decisions (and their creditors).
โ BOUNDARY CLAUSE: Structural Limitations
- Section 2036 (The Death Trap): If the parent continues to treat FLP assets as their own (e.g., paying personal bills from the FLP account), the IRS argues there was an “implied agreement” to retain possession. The entire value is pulled back into the estate at full price.
- Cost of Setup: FLPs are expensive. Legal setup ($5k-$15k) + Annual Appraisals ($2k-$5k) + Separate Tax Returns (Form 1065). The estate tax savings must outweigh these running costs.
๐ค DECISION BRANCH (Logic Tree)
IF Estate < $20M or Assets = 100% Cash/Public Stock:
โข Input: Low valuation complexity; Discounts likely challenged.
โข Output: Skip FLP. Use simpler trusts (IDGT/GRAT). The audit risk on “Cash FLPs” is high.
IF Estate > $30M & Assets = Real Estate / Biz:
โข Input: Illiquid assets; Desire to keep control but shift value.
โข Output: Execute FLP. Layer it with an IDGT (Installment Sale) to maximize the leverage of the discount.
The FLP is the bedrock of dynastic wealth planning. It turns the liquidity problem of real estate into a tax advantage, allowing families to pass down empires without being forced to sell them to pay the tax bill.