8946 / Are there any disadvantages to using the family limited partnership (FLP) structure?

As discussed in Q 8942, properly forming and maintaining a FLP as a genuine business entity is critical to ensuring that the benefits of the structure can be realized. One of the primary disadvantages of the FLP structure is that these formation and maintenance requirements can be complicated, and a family seeking to form a FLP will have to engage a team of advisors to provide expert advice (attorneys, CPAs, investment advisors and appraisers should all be consulted, both at the time of formation and throughout the life of the FLP). Because of this, FLPs are often very expensive to establish and maintain.

These costs can escalate during the life of the FLP. Whenever assets are transferred to the FLP, they should be appraised by a professional—generating additional expenses as more and more of the parent generation’s assets are transferred into the FLP.

Another disadvantage to the FLP structure is potential liability for the general partners. Because the general partners will remain liable for any liabilities of the partnership (i.e., a lawsuit brought against the FLP), only certain assets should be held by the FLP. Therefore, if the family wishes to transfer assets that could potentially generate liability for the general partners to the FLP, it is advisable that the actual FLP general partner be an LLC that is owned by the parent generation. If the FLP wishes to conduct active business that could result in liability, that business should be conducted through a corporation or LLC that the family partnership owns. Establishing these multiple tiers will generate additional costs and complexity.

Importantly, the presence of a FLP tends to attract the attention of the IRS, meaning that an estate tax return that includes a transfer of FLP interests may generate additional scrutiny. On a gift tax return, the taxpayer must specify whether the reported gifts were subject to a valuation discount (one of the primary advantages of the FLP, see Q 8945), making it easier for the IRS to identify the transfer as one deserving extra scrutiny.