A family limited partnership (FLP) is a partnership that holds a family’s assets, in which the senior generation keeps a small controlling general partner interest and gives away non-controlling limited partner interests that are valued, for US gift and estate tax, below their share of what the partnership owns.
In plain terms
Instead of giving away the assets, you give away pieces of the container holding them. The pieces are worth less than a proportional slice, because whoever receives one cannot vote, force a sale, get their money out, or easily find a stranger to buy in. An appraiser puts a number on that handicap and the gift is taxed on the reduced figure, while the parents keep a general partner interest that is often 1% of the economics and 100% of the decisions.
How it works
Assets — usually marketable securities, real estate, or an operating business — are contributed to a limited partnership or an LLC. The senior generation takes a small general partner interest and a large limited partner interest, then transfers the limited interests to children, or sells them to an IDGT in exchange for a note. A qualified appraiser then applies a valuation discount for lack of control and lack of marketability.
The IRS has attacked this for thirty years on two fronts. Section 2704 disregards certain lapsing rights and restrictions that exist only to depress value; proposed regulations that would have gone much further were published in 2016 and then withdrawn on October 20, 2017, and discounts survived largely intact.
The real risk is elsewhere. Section 2036 pulls the underlying assets back into the taxable estate at full, undiscounted value if the person who funded the partnership kept the enjoyment of them or a say over who does. In Estate of Powell (148 T.C. 392, 2017) the Tax Court held that even a limited partner’s ability to join with other partners to dissolve the partnership triggered inclusion. Courts have applied the same reasoning since, sometimes with a penalty on top. The escape hatch is the bona fide sale exception, which requires a real non-tax reason for the partnership and a family that behaves as though it exists.
The numbers
- Typical structure: 1% general partner interest, 99% limited partner interests.
- Combined discounts commonly claimed: 20%–40% off net asset value.
- What courts have allowed: the Tax Court has approved figures like a 15% minority discount plus a 24% marketability discount on limited partnership interests — well short of the most aggressive appraisals.
- What a failed FLP costs: the full undiscounted value returns to the estate, taxed at 40% above the $15,000,000 exemption (2026), after the family has paid for formation, annual appraisals, and separate partnership returns.
- Penalty exposure: 20% of the underpayment if the reported value is 65% or less of the correct value, 40% if it is 40% or less, under Section 6662.
- Key date: October 20, 2017 — the withdrawal of the proposed Section 2704 regulations.
What people get wrong
That the discount is the product and the partnership is paperwork around it. It is the reverse: the cases the IRS wins are almost never about appraisal percentages. They are about facts — the parent who funded the entity weeks before dying, kept paying personal expenses out of partnership accounts, never held a meeting, and had no purpose anyone could articulate that wasn’t tax. A failed FLP is strictly worse than no FLP, because the assets come home at full value and the family has paid a decade of costs for the privilege. The other quiet cost is basis: a discounted lifetime gift hands over a low cost basis, so estate tax avoided at 40% is partly recreated as capital gains tax when the next generation sells.
Related
Read more: Asset Protection: How the Wealthy Reduce Exposure to Risk · Inheritance: The Transfer of Wealth Between Generations · Generational Wealth: How Long Fortunes Actually Last
See also: Valuation discount · Estate tax exemption · Irrevocable trust · IDGT