Family Limited Partnership (FLP)
A Family Limited Partnership (FLP) is a limited partnership formed by family members primarily to consolidate family assets under centralized management, facilitate intergenerational wealth transfers through annual and lifetime gifts of limited partnership interests, and achieve valuation discounts that reduce the gift and estate tax value of transferred interests below their pro-rata share of underlying asset values.
The Family Limited Partnership is both a legitimate business structure and an estate planning tool, though the IRS views poorly implemented FLPs with considerable skepticism. The strategy typically involves a senior generation (the parents) transferring assets — marketable securities, real estate, closely held business interests, or family business operations — into a limited partnership. The parents retain general partnership interests and often a significant portion of limited partnership interests, while gifting or selling limited partnership interests to children or irrevocable trusts over time.
The estate planning power of an FLP derives primarily from valuation discounts. A 10% limited partnership interest in an FLP is worth less than 10% of the FLP's underlying net asset value because limited partners lack control (they cannot manage the partnership or force distributions) and their interests are not readily marketable (there is no established market for minority LP interests in family entities). Appraisers routinely apply combined discounts of 25-40% for lack of control and lack of marketability, meaning that gifting a $1 million LP interest (at underlying asset value) may generate a taxable gift of only $600,000-$750,000. The estate planning savings over large portfolios can be substantial.
The IRS has aggressively challenged FLPs under several theories. IRC Section 2036(a) brings assets back into the taxable estate if the decedent retained the right to income or possession. If a parent deposits personal assets into an FLP and continues to use the FLP assets for personal expenses, commingles funds, or fails to observe partnership formalities, the IRS argues the transfer was essentially illusory and includes the full underlying asset value in the estate. Cases such as Estate of Strangi and Estate of Bongard have resulted in full estate inclusion where economic substance was lacking.
To withstand IRS scrutiny, FLPs must be formed for legitimate non-tax purposes (centralized management of a family investment portfolio, protecting assets from creditors, facilitating business succession), must observe all partnership formalities, must have genuine economic substance, and the senior generation must retain sufficient assets outside the FLP to support their personal lifestyle without accessing FLP assets. The general partner should receive an appropriate management fee.
The FLP has largely been complemented or replaced in sophisticated estate planning by the Family Limited Liability Company (FLLC), which achieves similar results under state LLC laws with more flexible governance structures.