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FAMILY LIMITED PARTNERSHIPS & TAX SAVINGS
MINIMIZATION OF INCOME TAX
Family
Limited Partnerships (FLPs) accomplish income tax minimization via the
principle of "income spreading." The principle of income spreading
essentially allows for income to be spread among various partners of the
FLP, including children, who, if they are 14 or older, are usually in
lower tax brackets [income earned by children under 14 years of age is
taxed at their parents' income tax bracket]. Total taxes are thus less
than they would be if all of the income is taxed at the highest tax
bracket of the wealthy parents. ["Income spreading" is available to
partnerships actually engaged in business, e.g., owning or managing rental
property or owning a controlling interest in a business.]
Consider Dr.
Jones and his family. Assume that Dr. Jones is taxed at the highest income
tax bracket possible. On the other hand, Dr. Jones’ teen-aged children are
all students and each is in the lowest tax bracket.
If Dr. and
Mrs. Jones transfer their assets into FLPs, the FLPs become the owners of
the assets. Any income earned on these assets is no longer directly
taxable as Dr. Jones’ income, but instead is treated as income of the FLP.
Partnerships, including FLPs, are treated as “flow through” entities for
tax purposes. Income earned by an FLP “flows through” to the general and
limited partners of that FLP, and each partner's share of that income is
taxed according to the partner's tax bracket.
Thus, when
Dr. Jones' FLP's income “flows through” to each partner, each child will
pay income tax at his or her lower bracket on his or her share of the
income earned by that FLP. [The FLP may distribute or lend enough money to
each partner to pay the income taxes.] As a result, there is an overall
lower tax on the family’s income.
FLPs also
allow for another level of income tax minimization, similar to the income
tax deduction granted to an individual for contributing to a qualified
retirement plan. If an FLP is engaged in business, the FLP may employ Dr.
Jones, Mrs. Jones and each of their children to provide services to the
FLP (e.g., management, bookkeeping, rent collection, etc.).
The FLP can
therefore contribute pre-tax dollars to qualified pension plans on behalf
of the FLP’s employees. Contributions made by the FLP to such pension
plans would be tax-deductible expenses of the FLP, reducing the gross
income of the FLP prior to the “flow through” of net income to the
individual partners.
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