Income Tax Benefits of a Family Limited Partnership or Limited Liability Company

The U.S. income tax system discourages families from providing financial support for parents or relatives who need long term care in a care facility. In most cases, such support is not deductible -- and for many middle income families, the government takes half the marginal income of the family income producer. Thus, it may require $2 of income for each $1 that is used to help provide financial support to a parent in a nursing home.

Meanwhile, the parent or other incapacitated family member is often in a very low tax bracket due to having little income other than social security benefits. But there is a partial tax solution for families that own a business that is not a corporation or families with substantial investment income.

By operating a business as a Family Limited Partnership (FLP) or Limited Liability Company (LLC), the children can make gifts of the limited partnership interest to their parents without giving up future control of the business. By giving a parent 20% of a FLP/LLC, the parent receives 20% of the profits. The amount of the profit can be controlled to some extent by paying a guaranteed salary to the children who run the business.

For example, if a business is producing $100,000 a year of profits that are subjecting the owner to income and social security taxes, a 20% share given to a parent will divert $20,000 a year to the parent if there is no guaranteed salary. But if the primary owner of the business receives a guaranteed salary of $50,000, then the parent gets a profit distribution of $10,000.

In addition, the general partner of a FLP or the manager of a LLC has control over the amount of distributions. Even though the parent might receive 20% of the profits, the child may elect to only distribute 50% of the profits and leave the balance in the business.

For families that do not own a business, but that have substantial investment income the FLP/LLC can be used to divert income from those investments to the parent. For example, if there is a fund of $800,000 that can be safely invested to earn 4% per year, that would produce $32,000 per year of investment income. If the parent is the  owner of 80% of the FLP/LLC, then the parent would have $25,600 a year of investment income to help pay for the cost of an elder care facility.

If the parent has to live in an elder care facility due to a need for medical care or assistance with any of the activities of daily living, then the cost of the facility would be deductible by the parent and the income from the FLP/LLC would be offset by the deductions for medical care.

CAUTION: 

This arrangement would not be suitable if there is any intention to have the parent become eligible for Medicaid. The income from the FLP/LLC would usually make the parent ineligible.

This arrangement works best when the business owner is the only child of the parent. Thus, the share of the limited partnership or LLC will be left to the child when the parent dies. Where there are multiple children, it would be necessary to have a buy/sell agreement with the parent in order to regain control of the partnership or LLC interest that had been gifted.

This brief article does not deal with estate or gift tax issues of a FLP, which are discussed in the section on ElderLaw.

Copyright, 2003, Vernon K. Jacobs

Vernon Jacobs is the Editor/Publisher of The International Wealth Protection Reports, which are a collection of research reports on legal methods of asset protection and tax avoidance. Further information on this subject is available at http://www.offshorepress.com/  Jacobs is a CPA who has worked as a free lance tax and financial author/editor since 1977. Details about his credentials and experience are online at http://www.offshorepress.com/vkjcpa/  

ElderTax Index