The Structure Wealthy Families Use to Transfer Assets at a Discount
When a family with substantial wealth sits down to plan for the next generation, the conversation eventually turns to a structure that has been a staple of sophisticated estate planning for decades: the family limited partnership. It's
not a household name, and it's not something most people encounter, but it's one of the most effective tools available for transferring wealth while reducing estate taxes and preserving family assets. The family limited partnership allows a family to pool assets—real estate, marketable securities, a family business—into a single entity, and then transfer ownership interests to the next generation at a discounted value. That discount is the key: it allows more wealth to be transferred for the same amount of gift tax exemption, which can translate into millions of dollars of tax savings over time.The concept is straightforward once you understand the mechanics. A family limited partnership has two types of partners: general partners, who manage the partnership and have unlimited liability, and limited partners, who contribute capital but don't participate in
management and have liability limited to their investment. The senior generation typically serves as the general partner, retaining control over the assets, while the junior generation receives limited partnership interests through gifts or sales. Because the limited partners have no control and can't easily sell their interests, the value of those interests can be discounted for lack of marketability and lack of control. The FLP estate planning that works uses those discounts to transfer wealth more efficiently.What makes this particularly important right now is that the estate tax exemption is at a historically high level, but it's also subject to political risk. Families with substantial wealth have a real incentive to use the exemption while it's available, and the FLP is one of the most effective tools for doing that. The estate tax reduction strategies that work include the FLP for families with significant assets, because the discounts allow more wealth to be transferred before the exemption is exhausted.
How the Partnership Structure Works
A family limited partnership is typically formed as a limited partnership under state law, with the senior generation contributing assets to the partnership in exchange for both general and limited partnership interests. The general partner interests give the senior generation control over the partnership's operations—the authority to buy, sell, and manage the assets—while the limited partner interests represent the economic interest in the partnership. The senior generation can then gift limited partner interests to children or trusts for their benefit, reducing the estate while retaining control through the general partner interest.
The allocation of interests is a key design decision. The senior generation might retain a small general partner interest—often 1% to 2%—along with a significant limited partner interest, while gifting the remaining limited partner interests to the next generation. That structure gives the senior generation control over the assets while transferring most of the economic value to the children. The family wealth transfer that works uses that structure to achieve both control and transfer, which is the combination that makes the FLP so valuable.
The assets held in the partnership matter too. Real estate, marketable securities, and family business interests are the most common contributions, because they're the assets that are most likely to appreciate and most likely to benefit from the valuation discounts. The FLP can hold a diversified portfolio, a single piece of real estate, or a family business, depending on the family's goals. The asset protection planning that works uses the FLP to hold assets that the family wants to protect and transfer, rather than assets that are needed for current living expenses.
It's important to understand that the FLP is a partnership for tax purposes, which means it files its own tax return and allocates income to the partners according to the partnership agreement. The partnership itself doesn't pay tax; the partners report their share of the income on their personal returns. That pass-through treatment is one of the reasons the FLP is attractive for estate planning, because it avoids the double taxation that would apply to a C-corporation. The FLP estate planning that works uses the partnership structure to achieve both estate tax reduction and income tax efficiency.
The Valuation Discounts That Create the Savings
The valuation discounts are the heart of the FLP strategy, and understanding them is essential for evaluating whether the structure makes sense. There are two main types of discounts: lack of marketability and lack of control. The lack of marketability discount reflects the fact that a limited partnership interest is difficult to sell—there's no public market for it, and the partnership agreement may restrict transfers. The lack of control discount reflects the fact that a limited partner can't control the partnership's decisions or force distributions. The estate tax reduction strategies that work use those discounts to value the gifted interests at less than their proportionate share of the underlying assets.
The size of the discounts varies depending on the circumstances. Historically, discounts for lack of marketability have ranged from 20% to 40%, and discounts for lack of control have ranged from 10% to 30%, though the IRS has challenged aggressive discounts and the courts have become more skeptical in recent years. The family limited partnership that works uses discounts that are supported by a qualified appraisal and by the specific facts of the partnership, rather than discounts that are pulled from a textbook or a promoter's presentation.
An example illustrates the power of the discounts. Suppose a family contributes $10 million of assets to an FLP and gifts limited partner interests worth $8 million to the children. If the appraised value of those interests is discounted by 30%, the gift is valued at $5.6 million rather than $8 million, which means the family uses $5.6 million of their gift tax exemption instead of $8 million. The remaining $2.4 million of value passes to the children free of gift tax, which is a significant benefit. The family wealth transfer that works uses the discounts to transfer more wealth for the same exemption amount.
It's important to understand that the discounts aren't guaranteed. The IRS scrutinizes FLP valuations, and if the discounts are excessive or unsupported by the facts, the agency can challenge them and assess additional tax, penalties, and interest. The asset protection planning that works uses a qualified appraiser who understands the FLP structure and can support the discounts with a defensible analysis. The appraisal is the foundation of the strategy, and a weak appraisal can undermine the entire plan.
The IRS Scrutiny and the Rules You Must Follow
The family limited partnership has been the subject of extensive IRS scrutiny and litigation, and the courts have established a set of rules that families must follow to preserve the benefits. The most important is the "bona fide business purpose" requirement. The FLP must have a legitimate business purpose beyond tax avoidance—for example, centralized management of family assets, protection of assets from creditors, or preservation of the family business for future generations. A partnership that exists solely to reduce estate taxes is vulnerable to challenge. The FLP estate planning that works documents the business purpose and demonstrates that it's genuine, rather than a pretext.
The second rule is that the formalities must be respected. The partnership must have a written agreement, the partners must observe the formalities, and the partnership must be operated as a separate entity. If the senior generation treats the partnership assets as their own—using them for personal expenses, ignoring the partnership agreement, failing to make distributions according to the agreement—the IRS can argue that the partnership should be disregarded. The estate tax reduction strategies that work maintain the formalities and document the partnership's operations, because the credibility of the structure depends on it.
The third rule is that the partnership must have a legitimate investment purpose and must not be a mere holding device for personal assets. The IRS has challenged FLPs that hold only personal-use assets, like a residence or a vacation home, because those assets don't have a business purpose that justifies the partnership structure. The family limited partnership that works holds assets that are appropriate for the partnership—investment assets, business interests, rental properties—and demonstrates that the partnership serves a genuine investment purpose.
The fourth rule is that the senior generation can't retain too much control or too many benefits. If the senior generation retains the power to revoke the partnership, to control the timing of distributions, or to use the partnership assets for personal purposes, the IRS can argue that the partnership interests aren't a completed gift. The family wealth transfer that works structures the partnership so that the gifts are complete and the senior generation's retained interests are limited to the general partner role.
Combining the FLP With Other Strategies
The FLP is most effective when it's combined with other estate planning strategies, rather than used in isolation. The partnership can be the entity that holds the family's assets, while the limited partner interests are gifted to trusts for the children, which adds another layer of protection and control. The asset protection planning that works uses the FLP in combination with irrevocable trusts, because the trust protects the limited partner interests from the children's creditors and provides for professional management.
The FLP can also be combined with a grantor retained annuity trust, or GRAT, to transfer appreciation at a reduced gift tax cost. The FLP holds the assets, the GRAT holds a limited partner interest, and the appreciation above the GRAT's annuity passes to the children free of gift tax. The estate tax reduction strategies that work use the FLP and the GRAT together, because the combination achieves more than either structure alone.
It's also worth considering the role of life insurance. An irrevocable life insurance trust can hold a policy that provides liquidity to pay estate taxes, while the FLP holds the family's assets. The insurance provides the cash to pay the tax bill without forcing the sale of the FLP assets, and the FLP provides the structure to transfer the assets at a discounted value. The family wealth transfer that works uses the FLP and the ILIT together, because the two structures address different parts of the estate planning challenge.
Finally, the FLP should be reviewed and updated regularly. The tax law changes, the family circumstances change, and the value of the assets changes. A partnership that was appropriate when it was formed may need to be adjusted as the family grows and the assets appreciate. The FLP estate planning that works is the planning that's reviewed annually, with the partnership agreement and the valuation updated as needed. The goal isn't to set up a structure and forget about it. It's to maintain a structure that continues to serve the family's goals as the years pass.
Is the FLP Right for Your Family
The family limited partnership isn't for everyone. It's complex, expensive to set up and maintain, and it requires ongoing legal, tax, and valuation work. For a family with modest assets, the costs outweigh the benefits. The family limited partnership that works is the one that's used by families with substantial assets—typically $5 million or more—who have a genuine need to transfer wealth, reduce estate taxes, and protect assets from creditors.
The FLP is particularly valuable for families with closely held businesses, significant real estate holdings, or concentrated positions in marketable securities. Those assets are the ones that benefit most from the valuation discounts and the centralized management that the partnership provides. The asset protection planning that works uses the FLP for families with those types of assets, rather than for families whose wealth is primarily in liquid, diversified investments.
It's also worth considering the family dynamics. The FLP works best when the family is cohesive, when the senior generation is comfortable sharing control, and when the next generation is prepared to participate in the partnership. A family with significant conflict or a next generation that isn't ready for the responsibility may find that the FLP creates more problems than it solves. The estate tax reduction strategies that work are the ones that fit the family's culture and values, not just the family's balance sheet.
Finally, work with a team of professionals who understand the FLP structure—an estate attorney who specializes in partnership planning, a CPA who understands partnership taxation, and an appraiser who can support the valuation discounts. The family wealth transfer that works is the transfer that's designed and executed by professionals, not the one that's copied from a template or a seminar. The structure is powerful, but it's also complex, and the families who benefit most from it are the ones who respect its complexity and invest in getting it right.
