In this blog post, which again is more on the technical tax-side, I lay out five More Things to Remember About… FLP’s/LLC’s, continuing in the same vein as my previous blog post about five things to remember about structuring family entities and concludes with my version of the Ten Commandments for Family Entities.
Five More Things to Remember About FLP’s and LLC’s
6. FUTURE SHOCK
Consider the impact of generational “fan out” of ownership on governance of the FLP/LLC. This is one of the biggest challenges to drafting an FLP/LLC, but it usually is swept under the rug of expedience. Utilizing governance documents prepared for unrelated owners as guides for FLP/LLC documents causes the estate planner to never even consider the unique governance issues engendered by the expected change in ownership expected in the context of family estate planning. It doesn’t take much “generational fan out” in order to create significant logistical governance problems for the FLP/LLC, particularly if meetings are required and quorums are set rigidly.
Is it appropriate to consider assigning rights by defined “families” (usually each child and his or her descendants and assignees would constitute a “family”), either at the FLP/LLC management level (such as having each “family” select its own manager) or even at the FLP/LLC owner level (where each “family” votes the interests of all members as a block instead of individually)?
Should each family be given a right to assign its FLP/LLC interests into a separate entity for holding, with the new entity to vote the interests formerly held by the “family.” Should the well-crafted FLP/LLC prescribe a manner of division of the FLP/LLC, and even triggering events for that to occur?
7. VOTE EARLY AND OFTEN
Watch for and coordinate the amount of required votes. The required votes for events in FLP/LLC governance agreements must be carefully coordinated with the ownership shares of the owners, both before and after significant transfers of entity interests. This can have both tax and non-tax implications.
For example, suppose the FLP/LLC agreement provides that 2/3 of the owners by interests can dissolve the entity, and an owner holds more than that prescribed percentage. At that owner’s death, the interest will be entitled to a relatively small discount for lack of marketability. Recall, for instance, that in Jones v. Comr., 116 T.C. 121 (2001), the Tax Court determined that no discount for lack of marketability was appropriate for a gift of a limited partnership interest because the partnership agreement gave the donated partnership interest, by virtue of its size, the effective right to dissolve the partnership.
8. DIFFERENT STROKES FOR DIFFERENT FOLKS
It is important to carefully consider the number and types of FLP’s/LLC’s that a client may need. One of the more subjective challenges in FLP/LLC design is deciding how many entities the client should have. This challenge has tax and non-tax aspects. In some situations, the client should set up separate entities for different descendants. In other situations, the nature of the underlying property informs the number: property that is susceptible to liability often should be kept separate from other property.
9. DON’T KEEP IT ALL IN THE FAMILY
Protections against family informality are critical. Despite all of an estate planner’s best efforts and exhortations, families may still act over the kitchen table with their FLP’s/LLC’s in a manner that may call the separate existence of the FLP’s/LLC’s into question.
For instance, families sometimes make non-pro rata distributions or engage in disparate timing of pro rata distributions. Drafters should anticipate this reality by considering treating these distributions as “interim” and providing for preferential “makeup” distributions and charging interest at the IRC Sec. 7872 rate on “interim” balances that exceed $10,000.
In some circumstances, it may be prudent to provide additional rights (and obligations) upon certain family assignees who are not automatically admitted as owners. This can be a particularly helpful provision where there are transfers to trusts in which spouses of family members have interests, e.g., QTIP trusts, etc.
In considering allocations of income and distributions of cash, it is important to be very cautious before instituting any scheme that is other than a straight allocation and distribution along percentage ownership lines. Any preference could subject the FLP/LLC to the Balkan provisions of IRC Sec. 2701. While there are situations in which estate planners may want to use IRC Sec. 2701, the application of that section should be a consciously desired result. The only real way to avoid application of IRC Sec. 2701 is to make all FLP/LLC interests the same in quality.
Sometimes, clients desire distribution preferences in the form of “guaranteed payments” pursuant to IRC Sec. 707. This should be used very carefully as there is potential exposure under IRC Sec. 2036, especially if the amount of the guaranteed payment just so happens to equal anywhere close to the amount of income that the property generated when contributed to the FLP/LLC. For example, in Harper Est. v. Comr., supra, the donor received a guaranteed payment on the making of a gift of partnership interests. The Tax Court held that IRC Sec. 2036 applied.
10. TAXING ISSUES
Don’t forget the income tax issues of FLP’s/LLC’s. Years ago, the income tax rules relating to partnerships permitted all sorts of flexibility and asset transfers. In fact there was so much flexibility that the rules invited and elicited abuse. The result was a tightening of rules.
Code Section 704(e) has always provided some restrictions on FLP’s/LLC’s in which capital is not a significant income producing factor. However, the rules relative to distributions of marketable securities have been tightened, as have the rules pertaining to allocations of items of FLP/LLC income, gain, loss, deduction and credit. Other changes pertaining to transfers of property out of a partnership have increased the risk of a taxable event under IRC Secs. 707(a)(2) and 737. There are other income tax issues discussed earlier.
The bottom line: the FLP/LLC cannot be set up to just comply with estate tax rules; the income tax rules are very important.
THE TEN COMMANDMENTS OF FAMILY ENTITIES
With all due respect to the Deity (and to the Moonglows), what follows are a set of rules for clients who desire to set up FLP’s/LLC’s that they should keep like the Ten Commandments:
- Thou shalt respect thine own agreement.
- Thou shalt immediately retitle all property contributed to the FLP/LLC.
III. Thou shalt act as a fiduciary and resisteth the penchant for over-control.
- Thou shalt not make non pro rata distributions.
- Thou shalt not commingle assets or income.
- Thou shalt contemporaneously and accurately account (IRS doth not like after-the-fact adjusting entries).
VII. Thou shalt not covet thy FLP’s/LLC’s property.
VIII. Thou shalt keep personal use and liability prone property out of thy FLP/LLC.
- Thou shalt get quality appraisals of both FLP/LLC assets and any FLP/LLC interest to be gifted.
- Thou shalt batten thy hatches. The IRS is not a big fan of FLP’s/LLC’s.
Latest Episodes:
We released two episodes of The Cajun Counselor podcast in February – click below to tune in!
Episode 7: Family Meetings and Irish Whiskey Bequests aired on March 4, 2026 and in it, I celebrated the spirit of Carnival season and shared a few of my favorite king cake memories. Beyond the festivities, I dove into the core philosophies that drive my practice, including client empowerment in estate planning, and some stoic wisdom from the works of Marcus Aurelius.
In Episode 8: Estate Planning Beyond Taxes and Trusts, which aired on March 18, 2026, I welcomed our second guest to the show! In an engaging interview, John A. Warnick and I explore the human side of estate planning, emphasizing the importance of purposeful planning, effective client communication, and innovative ideas like ethical wills.