A limited partnership (LTD) is a hybrid of a corporation and a partnership. The general partners manage the business on a day-to-day basis and are personally liable for the debts and liabilities of the partnership. However, the limited partners do not participate in the management of the business and only their assets used for purchase of their partnership interest are at risk for the debts and liabilities of the partnership.
To form a limited partnership, a filing must be made with the State, and the formalities set forth in the statutes must be followed. Included in the partnership are both general and limited partners. The general partners are personally liable for all of the liabilities of the partnership and have control of it. In contrast, the limited partners have limited liability (that is, their only risk is their investment) and can have only limited input into the management and control of the partnership. Limited partners are similar to shareholders and general partners to partners, thus its hybrid nature.
Unlike a general partnership, a limited partnership cannot be formed informally. A certificate of Limited Partnership must be filed with the State and a written partnership agreement established.
The limited partnership is taxed for income tax purposes in the same manner as a general partnership. It is a flow-through entity. It files an informational return showing the allocation of income and loss among the partners, and then the partners must claim the income and losses on their own returns.
Limited partnerships were used in the past as the entity of choice for tax shelters. Since the “demise” of tax shelters, they have fallen out of favor. However, limited partnerships are an extremely effective tool for estate tax planning. Most of the estate tax benefits of partnerships are also available in the limited liability company.
For individuals with assets valued at more than $2 million ($3 million in the case of a married couple), the usual living trust planning is insufficient to completely insulate them from estate taxes. A common wish of such individuals is to make annual gifts of up to the annual gift tax exclusion (currently $11,000) to individual family members, reducing the size of their estate both by the amount given and the future increases in value of the assets. However, outright gifts can be disconcerting to the giver due to the loss of control, especially in ongoing businesses. Furthermore, some types of assets (i.e. real estate) can be difficult and messy to divide into the appropriate amounts. By creating a family limited partnership, we can place assets into the partnership and gift away limited partnership shares or units. This can simplify the gifting and maintain the control in the original owner.
Besides control and simplification benefits, the family limited partnership can have dramatic estate tax benefits over outright gifting. Since the interests owned in a family limited partnership are not particularly marketable and there is little if any control, these interests are “discounted” for gift and estate tax purposes. For example, if you give a gift of a 1/10th interest in a piece of real estate worth $100,000, you have made a gift for gift taxes purposes of $10,000. If, on the other hand, you make a gift of a 1/10th interest in a family limited partnership that owns a $100,000-piece of real estate, your gift may be valued for gift tax purposes at $5,000 or $6,000. In other words, you can gift more without adverse tax consequences. Furthermore, when the general partner dies, his or her interest becomes a limited partnership interest and can receive the same type of valuation discounts. Please note, however, that discounts have fallen into disfavor with the IRS in recent rulings and therefore should be used only with great care.
Simply put, the family limited partnership can be an extremely powerful estate planning tool. It is not for everyone, but can significantly decrease estate and gift taxes in the appropriate circumstances.