If you own and administer a family business, a family limited partnership (FLP) or family limited liability company (FLLC) may play a crucial role in your estate plan. According to a recent study published by the American Bar Association in 2022, family limited partnerships (FLPs) can be a useful tool for wealth transfer planning for retirees and high net worth individuals. FLPs allow family members to pool their assets and transfer them to the next generation while maintaining control over the assets during their lifetime. This can result in significant tax savings and asset protection benefits for retirees and their families. FLPs can also be used to facilitate the transition of ownership and control of family businesses to the next generation while minimizing estate and gift taxes.
What is an FLP/FLLC?
Our Alcoa clients frequently inquire about FLPs and FLLCs. A FLP is a unique type of limited partnership in which family members function as general and limited partners. A FLLC is a corporation owned by family members, who may or may not act as administrators. With an FLP, the business is managed by general partners. Limited partners have neither a vote nor a say in day-to-day operations, but they have limited liability; they are not responsible for the FLP's obligations in excess of their capital contributions. Even if they function as managers, all family members with a FLLC have limited liability (as with any corporate entity).
Note: The rest of this discussion will refer to an FLP; however, the underlying principles apply to FLLCs as well.
A typical limited partnership consists of a general partner with experience and limited partners with capital. However, in the family context, the senior generation typically begins as both the general and limited partners. The older generation then transfers the limited partnership interests to the junior generation. The general partners may transfer up to 99% of the business to the limited partners while retaining no more than 1%. This can be an excellent solution for our Alcoa clients who wish to transfer ownership of their business to their children but wish to retain control until their children gain experience and become capable of managing the business independently.
Asset Protection
A FLP can provide limited partners with some level of asset protection. A court order (called a charging order) is typically required for a creditor to reach a limited partnership interest, and even then, the FLP is only required to pay the creditor instead of the partner until the debt is paid. In this instance, the creditor does not serve as a replacement partner. He or she must wait until the general partner decides (which could take a very long time) to distribute income. Additionally, FLP assets are protected from divorce-related loss. However, the general partner does not receive the same protection and is personally liable for the FLP's debts and liabilities.
Income Tax Considerations
A FLP is a pass-through entity for purposes of income taxation. This means that the IRS does not recognize an FLP as a taxpayer (as it does for a corporation), and that the FLP's income is passed through to the partners. Therefore, you can transfer business income and prospective appreciation of business assets to family members in a lower tax bracket. The entire family can benefit from tax savings. From 2018 to 2025, an individual taxpayer may deduct 20% of domestic qualified business income (excluding compensation) from an FLP, subject to various limits.
Tip: The partners must report the income earned by the FLP on their personal income tax returns and are responsible for payment of any tax owed. Income is allocated to each partner based on his or her share of the contributed capital (i.e., pro-rata share).
Gift and Estate Tax Considerations
Utilizing the annual gift tax exclusion and applicable gift and estate tax exclusion amounts: Gifts of interests in an FLP are subject to federal (and potentially state) gift tax. Nonetheless, you can reduce or eradicate your actual gift tax liability by transferring FLP interests in amounts exempt from gift tax under the annual gift tax exclusion ($15,000 per recipient in 2019 and 2020). In addition, each taxpayer has a federal gift and estate tax applicable exclusion amount equal to the basic exclusion amount of $11,580,000 (in 2020, $11,400,000 in 2019) plus any unused spousal exclusion amount, so transfers that do not qualify for the annual gift tax exclusion are exempt from gift tax up to the extent of your available applicable exclusion amount. Both the annual exclusion and the baseline exclusion amount are inflation-indexed and may increase in the future.
Using value reductions: You may be able to deduct the value of the donated FLP interests. This is because limited partners have very limited rights, including the incapacity to transfer an interest, withdraw from the FLP, and participate in management. These restrictions can cause a business's value to be substantially less than the value of its underlying assets. These discounts can be substantial, accumulating up to 35% off. Minority interest (lack of control) and absence of marketability discounts are among the available discounts.
Removing appreciation in the future from your estate: In general, business assets appreciate (increase in value) over time. By distributing your assets among family members (via the FLP), the current value is frozen and any future appreciation is excluded from your estate. You may be required to pay gift tax now, but the amount will be less than if the tax were calculated on a higher future value.
FLPs Must Comply With State Law and IRS Requirements
A FLP is subject to stricter regulations than other business entities. To establish a valid FLP in the eyes of the state and the IRS, care must be taken. A FLP will only be recognized if it was created for a legitimate business purpose. If the IRS or state determines that the FLP was formed solely to avoid taxes, the FLP form will be discarded.
Among the specific reasons for creating an FLP are:
To adopt a succession plan for the family
To facilitate senior citizens' annual gift-giving
To reduce income, gift, and estate tax liabilities
To safeguard assets against prospective creditors
To prevent successors from wasting assets.
To combine assets within a single entity.
To maintain the business within the family
To decrease estate and probate costs
A FLP may also own a closely held business (other than a corporation that has elected to be taxed as a 'S' corporation), real estate, marketable securities, and virtually any other investment asset. Homes, cottages, and other assets for personal use are typically unsuitable for an FLP.
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Tips For Forming And Maintaining A Valid FLP:
Create the FLP for one or more substantial nontax reasons, such as asset protection.
Keep accurate records
Develop the FLP while you are in excellent health.
Observe all legal requirements when forming the FLP and running the business.
Employ a third-party evaluator to assess the value of assets entering the FLP.
Transfer legal ownership of assets to the FLP
Put only business assets into the FLP; personal assets should not be included.
If you include personal assets, such as your residence, in your FLP, you must pay fair market rent for their use.
Don't combine FLP and personal assets; keep them distinct.
Never use FLP assets for your own benefit.
Maintain sufficient assets outside the FLP to cover personal expenses.
Distribute income to companions pro rata
Conclusion
A family limited partnership can be compared to a well-constructed retirement plan. Just as a retirement plan can help individuals protect and grow their assets for the future, a family limited partnership can help families preserve their wealth and pass it on to future generations. Like a retirement plan, a family limited partnership requires careful planning and management to ensure its success. It's essential to have a solid strategy in place to maximize the benefits and minimize potential risks. By working with experienced professionals and staying vigilant, families can enjoy the long-term benefits of a well-constructed family limited partnership, just as they can with a thoughtful retirement plan.
What are the key eligibility requirements for employees to participate in the Pension Plan for Certain Hourly Employees of Alcoa USA Corp, and how do these requirements change if an employee is hired or rehired after April 1, 2022? This question aims to explore the specific criteria that must be met for participation in the plan, providing clarity on both the general eligibility for new employees and any exceptions for those previously employed.
Eligibility Requirements: Employees are automatically eligible for the Pension Plan for Certain Hourly Employees of Alcoa USA Corp if they were hired or rehired before April 1, 2022, have reached age 21, and completed one year of vesting service. Employees hired or rehired on or after April 1, 2022, are not eligible for this pension plan(Alcoa USA Corp_Pension …).
How is the vesting service calculated in the context of the Alcoa USA Corp pension plan, and what implications does it have for an employee considering retirement? Understanding the nuances of how vesting service is accrued and the minimum time required to become vested can significantly impact an employee's retirement planning.
Vesting Service Calculation: Vesting service determines when an employee becomes eligible for pension benefits. Employees become vested after completing five years of vesting service, which includes both periods of pension service and non-pension service such as absences not counted towards pension service. This is crucial for retirement planning, as it ensures employees are entitled to pension benefits even if they leave the company after becoming vested(Alcoa USA Corp_Pension …).
What various retirement options are available to employees of Alcoa USA Corp, and how do these options affect the benefits and payout structure for retiring employees? This question addresses the multiple choices employees face when planning their retirement, including the differences between normal retirement, early retirement, and disability retirement benefits.
Retirement Options: The plan offers normal retirement (at age 65 with five years of vesting service), 60/10 retirement (for employees between 60 and 62 with 10 years of vesting service), and 62/10 retirement (for employees between 62 and 65 with 10 years of vesting service). Disability retirement is also available for those permanently incapacitated with 10 years of vesting service(Alcoa USA Corp_Pension …).
Can you elaborate on the survivor benefits provided under the Alcoa USA Corp pension plan, and what steps need to be taken to ensure that a spouse or partner is eligible for these benefits upon the employee's retirement? This question seeks to examine the protections and financial security afforded to survivors, alongside the required documentation and choices available to employees.
Survivor Benefits: The pension plan provides automatic surviving spouse coverage unless waived by the employee and spouse. Surviving spouse pensions are payable if the employee dies while actively employed and vested in the plan, after retirement, or while receiving a deferred vested pension. The spouse must submit a written application to claim benefits(Alcoa USA Corp_Pension …)(Alcoa USA Corp_Pension …).
What are the specific methodologies used to calculate the regular monthly pension for employees retiring under the Alcoa USA Corp pension plan, and how might these calculations vary based on an employee's age and years of service? This question looks at the complex actuarial factors that influence pension benefits, enhancing employees' understanding of how their retirement income is determined.
Pension Calculation: The regular monthly pension is calculated using a formula based on the employee's pension service and a pension factor in effect when pension service ends. For example, if an employee retires at 65 with 10 years of service, the pension factor might be $57 per year of service. The pension is adjusted based on age and service length(Alcoa USA Corp_Pension …).
In the event of a disability, how does the Alcoa USA Corp pension plan provide support to affected employees, and what are the requirements to qualify for disability retirement benefits? This question emphasizes the importance of understanding disability provisions, ensuring employees are aware of their rights and the circumstances under which they might qualify for benefits.
Disability Retirement: Employees under 62 who are permanently incapacitated with at least 10 years of vesting service qualify for disability retirement. They must be deemed permanently disabled and unable to return to work in a bargaining unit occupation. A medical examination may be required to confirm ongoing eligibility(Alcoa USA Corp_Pension …).
What steps must Alcoa USA Corp employees take to apply for retirement benefits, and what timelines are involved in the processing and payout of these benefits? This question delves into the procedural aspects of retirement applications, aiming to prepare potential retirees for the necessary actions they must undertake.
Retirement Application Process: Employees must file a retirement application with the plan administrator before their desired retirement date. The application can be filed up to 90 days before retirement, and the process typically includes receiving benefit explanations and payment elections within this timeframe(Alcoa USA Corp_Pension …).
How does the Pension Benefit Guaranty Corporation (PBGC) influence the pension benefits received by employees of Alcoa USA Corp, particularly in the context of plan terminations or financial challenges? This question explores the security provided by the PBGC, focusing on its role as a backup for employees’ pension benefits.
Pension Benefit Guaranty Corporation (PBGC): The PBGC provides a safety net for pension benefits in the case of plan termination or financial distress. If the pension plan is underfunded, the PBGC ensures employees still receive pension benefits, although certain limitations may apply(Alcoa USA Corp_Pension …).
What resources and support does Alcoa USA Corp provide to its employees for understanding their pension plan, and how can employees reach out for assistance regarding their retirement options? This question emphasizes the resources available to employees for further education and guidance, ensuring they know where to turn for help.
Resources for Understanding the Plan: Employees can access information about their pension plan and retirement options through the Alight Worklife™ website or by calling the Alcoa benefits helpline. These resources offer guidance on applying for retirement and understanding plan benefits(Alcoa USA Corp_Pension …).
How can employees of Alcoa USA Corp contact the benefits management team to learn more about their specific pension plan details, and what channels are available for inquiries? Understanding the communication channels can empower employees to seek the information they need, facilitating a smoother transition into retirement.
Contacting Benefits Management: Employees can reach out to the benefits management team through the Alight Worklife™ website or by phone at 1-844-31ALCOA. This service provides assistance with pension-related inquiries and retirement applications(Alcoa USA Corp_Pension …).
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