Overview

Family Limited Partnerships (FLPs) are a familiar tool in estate planning for families who own closely held businesses, real estate, or concentrated investment holdings. An FLP combines centralized management (via general partner(s)) with transferrable ownership (limited partner interests). The structure can preserve family control while enabling multi‑generation transfers of economic value in a tax‑efficient manner.

In my 15 years advising business‑owning families, I’ve found FLPs can be especially useful when the goal is to: keep operating control with one generation, gradually move wealth to heirs without immediate liquidity needs, and consolidate management of diverse or illiquid assets. That said, benefits depend on careful drafting, sound valuations, and ongoing compliance.

Sources and further reading: IRS guidance on Family Limited Partnerships (IRS), and the American Bar Association coverage on FLPs. See also FinHelp pieces on “Life Insurance in Estate Planning: Strategies for Liquidity and Protection” and “Estate Planning: Funding Your Estate Plan — Practical Steps” for complementary strategies.

Life Insurance in Estate Planning: Strategies for Liquidity and Protection

Estate Planning: Funding Your Estate Plan — Practical Steps

Family Limited Partnerships: Estate Planning Uses and Pitfalls

The legal and tax mechanics — how FLPs produce tax efficiencies

Structure: An FLP is a state‑law limited partnership. Typically:

  • One or more general partners (GPs) hold management rights and owe fiduciary duties to the partnership.
  • Limited partners (LPs) hold economic interests with restricted control and transferability.

Tax mechanics that can reduce gift and estate taxes:

  1. Valuation discounts: Gifts of LP interests often reflect discounts for lack of control and lack of marketability. A minority interest in a family business is usually worth less than a pro rata share of a controlling interest, and that reduced value lowers the reported gift amount (and, ultimately, estate inclusion). Discounts depend on facts and are supported by appraisal analysis and case law, but they are not guaranteed.
  2. Gift timing: By gifting LP interests over time (using annual gift exclusions or lifetime exemptions), owners can move value out of their taxable estate gradually.
  3. Centralized management + limited transferability: The GP retains operational control while economic benefits flow to LPs. This lets senior family members control the business while reducing their taxable holdings.

IRS and courts scrutinize FLPs. The IRS may challenge discounts if the FLP is a tax‑avoidance sham — for example, if limited partners have de facto control or if distributions and records don’t match the written agreements. See IRS guidance on Family Limited Partnerships for the agency’s viewpoint (irs.gov/businesses/small-businesses-self-employed/family-limited-partnerships).

Who benefits most from an FLP?

Typical candidates:

  • Owners of closely held businesses or family real estate with substantial nonliquid value.
  • Families wishing to preserve active control in one generation while providing economic benefits to heirs.
  • Individuals seeking structured, multi‑stage wealth transfers with the potential for valuation discounts.

Less suitable when:

  • Assets are highly liquid and easily marketable (discounts may be small).
  • Ownership transfers need immediate liquidity for heirs.
  • State law or creditor risks make the partnership ineffective.

Steps to set up an effective FLP

  1. Assemble a team: tax attorney, CPA experienced in partnership taxation, and a qualified business appraiser. Each role is critical — lawyers draft the partnership agreement, CPAs handle tax filings, and appraisers support valuation positions.
  2. Draft a partnership agreement: clearly state GP powers, LP restrictions, capital accounts, distribution rules, buy‑sell provisions, and valuation policies for transfers. The document should reflect real economic substance, not just tax goals.
  3. Capitalize the FLP: transfer assets (business interests, real estate, investments) into the partnership in exchange for partnership interests.
  4. Obtain independent valuations: get a formal appraisal at the time of gifting and retain an expert who can testify to valuation methods if challenged.
  5. Make gifts or sales of limited‑partner interests: use annual exclusions where possible; document each transfer and maintain partnership records.
  6. Operate the FLP as written: hold meetings, keep minutes, follow distribution and management provisions, and report taxes correctly.

Governance, control and family dynamics

Good governance reduces family conflict and undermines IRS challenge risks. Best practices include:

  • Use a formal governance calendar and minutes for meetings.
  • Define distributions and compensation policies to avoid mixing personal and partnership funds.
  • Consider independent or neutral GPs/managers for conflict resolution.
  • Create dispute resolution provisions in the agreement.

From my practice: simple, transparent rules tend to age better than complex, tax‑centric provisions. Families that run an FLP more like a business — with clear records and regular oversight — get better long‑term results.

Common pitfalls and IRS scrutiny

  1. Sham transfers: The IRS will recharacterize transfers that lack economic substance. Keep records showing gift intent and economic reality.
  2. Overstated discounts: Valuations must be defensible. Discounts commonly range, and depend on the asset and market conditions; do not rely on arbitrary percentages.
  3. Mixing personal and partnership assets: Avoid paying personal expenses from partnership accounts or treating partnership property as personal.
  4. Failure to follow formalities: No meetings, no minutes, and no partnership bank accounts invite challenge.
  5. State law traps: Partnership tax treatment and creditor protection vary by state — get local counsel.

Alternatives and complements to FLPs

Consider these if FLPs are not a fit:

  • Grantor Retained Annuity Trusts (GRATs) for shifting future appreciation.
  • Intentionally Defective Grantor Trusts (IDGTs) for estate tax planning while keeping income tax benefits.
  • Irrevocable trusts and family limited liability companies (LLCs), which can offer similar control and transfer benefits.
  • Life insurance to provide liquidity for estate taxes (see our article on life insurance and estate planning).

Choice depends on goals — control, creditor protection, tax exposure, and family needs.

Practical examples (anonymized)

Case A — Business transfer with control retained: A family transferred 40% of a closely held business into an FLP, then gifted limited interests to children over five years. Because the limited interests lacked control and were not readily marketable, the family used valuation discounts to lower reported gift values. They retained GP control while reducing their taxable estate. Independent appraisals and documented distributions preserved the plan.

Case B — Farm succession: A farming family placed land and equipment into an FLP, allowing parents to sell limited interests to children while remaining active managers. The FLP protected the farmland from forced liquidation and aligned ownership without splitting management authority.

These examples illustrate common outcomes but are not guarantees of tax results.

Professional tips

  • Get a written appraisal before gifting — it’s the single most important document in supporting discounts.
  • Use annual gift exclusions aggressively, but monitor aggregation rules and splitting rules with spouses.
  • Maintain robust minutes and records that show the FLP operates as a real business entity.
  • Revisit your FLP when laws or family circumstances change; what made sense at formation may not remain optimal.

Regulatory and authority notes

Always confirm current numbers and rules (gift exclusion amounts, estate tax thresholds, and state law) directly with IRS publications or by consulting a qualified attorney or CPA.

Conclusion and next steps

An FLP can be a powerful, flexible tool to transfer business interests while preserving control and potentially lowering estate and gift tax exposure. However, the structure requires careful legal drafting, credible appraisals, disciplined governance, and ongoing compliance. If you are considering an FLP, assemble a specialized team (estate attorney, CPA, appraiser) and document both the economic substance and family intent.

Professional disclaimer: This article is educational and does not constitute legal, tax, or financial advice. For advice tailored to your situation, consult a qualified estate attorney or tax advisor.

Further reading on FinHelp:

Authoritative sources: IRS, American Bar Association, professional appraisers and qualified tax counsel.