For many people, owning a small business is part of the “American Dream.” If you are one of those people, and you hope to one day pass down your business to the next generation, it is crucial that you plan accordingly within your estate plan. There are a number of tools and strategies that can be used to help your business make a successful transfer to the next generation, including a Family Limited Partnership. A Family Limited Partnership, or FLP, is one type of legal entity that works particularly well for small, family owned businesses. To help you become more familiar with an FLP, a Rochester business planning attorney at the Law Office of Michael Robinson, P.C. explains how a Family Limited Partnership works.
The Importance of Choosing the Right Business Structure
When starting a small business, you are required to make a number of very important decisions that will directly impact the success of your business. Choosing the right business entity for your new business is one of the most important of those decisions.
Traditionally, there were three basic entities from which a business owner could choose – sole proprietorship, partnership or corporation. A sole proprietorship is the default structure when a single individual is operating a business and has done nothing to form any other type of entity. A partnership exists when two or more people operate a business and share in the profits of that business. You are not required to execute any legal documents to form a partnership; however, many partnerships do operate under a Partnership Agreement. Finally, a corporation requires the owners to file Articles of Incorporation and a number of other legal documents. A corporation is actually run by a Board of Directors and the “owners” are the shareholders.
The type of entity you form will impact important aspects of your business, such as:
- Taxation – a corporation actually pays taxes separate and apart from any taxes owed by the shareholders for profits passed down to them. This is referred to as “double taxation.” The owners of a partnership or sole proprietorship, on the other hand, only pay “pass through” taxes on the profits passed through to the owners. Also, some corporations may make a “Subchapter S” election to have the corporation’s profits taxes directly to the shareholders as individuals, thus avoiding the “double taxation.”
- Liability – only a corporation shields owners from the debts and liabilities of the business – and even then it must be a true corporation, not just one in name only.
- Management – the entity you chose will affect how the business is managed and your role in that management structure.
- Investment and growth – if you hope to grow the business in the future, a corporation is typically the most attractive type of legal structure for investors.
From the traditional three types of business entities, numerous sub-categories and hybrids evolved. One of those is the Family Limited Partnership.
How Does a Family Limited Partnership Work?
A limited partnership is a partnership that has two different types of partners – general partners and limited partners. General partners control all management and investment decisions and bear all of the liability for debts and other liabilities of the partnership. Limited partners cannot participate in the management of the limited partnership and have limited liability. Like all partnerships, the profits and losses of the business are passed through to the partners in proportion to their interest in the business. The partnership itself does not pay taxes. A FLP is a specific type of limited partnership.
A family limited partnership is simply a limited partnership that is owned by family members. Typically, in an FLP the older members of the family contribute property, cash, or other assets to the business in exchange for a small general partner interest and a large limited partner interest. Over time, they then gift their limited partner interest to the younger members of the family. Eventually, the entire business is passed down to the next generation of partners. Along with providing a smooth transfer of management, a Family Limited Partnership can also decrease the taxes that are often imposed when transferring business assets.
Contact a Rochester Business Planning Attorney
For more information, please join us for an upcoming FREE seminar. If you have additional questions about choosing the right type of entity for your business or about business succession planning for your small business, contact a Rochester business planning attorney at the Law Office of Michael Robinson, P.C. by calling 585-374-5210 to schedule an appointment.
Michael Robinson, Estate Planning Attorney
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