As a CPA and owner of an accounting firm, you’ve spent years building your practice and serving your clients. Now, as you look towards the future, you’re likely considering how to best transfer your firm to the next generation while minimizing tax implications and maintaining control during the transition. Two powerful tools for accomplishing these goals are the Family Limited Partnership (FLP) and the Family Limited Liability Company (LLC). This article will compare these structures and help you determine which might be the best fit for your accounting firm’s succession plan.
TCJA Sunset and Your Succession Plan
We are currently enjoying high lifetime exclusion limits, but these high limits are likely to end soon. In 2024, you can pass down up to $13.61 million to a beneficiary or beneficiaries without owing any estate or gift tax. At the end of 2025, the Tax Cuts and Jobs Act will most likely expire, and that limit will be reduced to its previous level of $5.49 million, adjusted for inflation. If your estate will be worth more than that by 2026, you may want to begin reducing your taxable estate sooner rather than later. One of the most efficient ways of doing so is to restructure your business and begin transferring its assets to your beneficiaries.
Understanding Family Limited Partnerships
An FLP is a company comprising one or more general partners (typically the current firm owners) and limited partners (often children or other family members). As a CPA firm owner, you and potentially your spouse or business partner would serve as general partners, maintaining control over the firm’s operations and decision-making processes. Your children or other designated successors would become limited partners, allowing them to benefit from the firm’s profits without immediate management responsibilities.
The FLP is a pass-through entity for income tax purposes. This means that the IRS does not recognize the FLP as a separate taxpayer, unlike corporations that pay taxes on its profits, and then passes those profits to its shareholders who get taxed on their dividends. The income earned by the FLP passes through to the individual partners, who then must report their share of the income and other items of the FLP on their personal income tax returns.
Additionally, the shares of the FLP may qualify for valuation discounts, such as lack of marketability and minority interest discounts. When these shares are passed down, they may benefit from a reduced value at the time of the transfer, potentially reducing capital gains taxes when they eventually sell the assets.
For example, let’s say you have a 80% interest in your FLP, and your child has a 20% interest for a total valuation of $1,000,000. It would be difficult for your child to find a buyer of that 20% interest for $200,000 because the buyer wouldn’t have any control over the business. Nor is there a standardized marketplace, such as the stock market, for investors to purchase those shares, further reducing their value via a lack of marketability. You can now gift more shares to your beneficiary than you otherwise could due to the reduced valuation.
Those shares may eventually grow in value. When gifted, the recipient’s basis for capital gains will typically be the donor’s original basis, not the discounted valuation used for gift tax purposes. This means that the capital gains tax will be applied to the difference between the sale price and the donor’s original basis. However, if the shares are inherited, the basis will be “stepped up” to the fair market value at the time of the donor’s death, potentially reducing capital gains taxes for the recipient when they sell the assets.
Example Calculation of Valuation Discounts
Lack of Marketability Discount: Assuming a 20% discount:
$200,000 x 20% = $40,000
Adjusted Value: $200,000 – $40,000 = $160,000
Minority Interest Discount: Assuming a 15% discount on the adjusted value:
$160,000 x 15% = $24,000
Final Adjusted Value: $160,000 – $24,000 = $136,000
FLP shares can also be gifted. With an FLP, you can gift shares to your children or other beneficiaries up to the Annual Gift Tax Exclusion without triggering gift taxes, operating as a gradual, tax-efficient transfer of your firm’s value. In 2024, you can gift up to $18,000 per recipient. If you exceed that limit, the excess amount will be deducted from your lifetime exclusion limit.
There’s also a layer of protection built in. Your limited partners have their personal assets (minus their initial investment) shielded from the firm’s liabilities.
Unfortunately, FLPs aren’t all smooth sailing. They’re complex and require careful structuring and ongoing maintenance to keep the IRS happy. As a general partner, you’re still exposed to the firm’s liabilities and potential lawsuits – a risk that you might find unpalatable. Also, let’s not forget the costs. Setting up and maintaining an FLP can be pricey, with legal and administrative requirements (both state and federal) that might make you reconsider.
Understanding Family Limited Liability Companies (Family LLCs)
Another option you may want to consider is the Family Limited Liability Company (LLC). You might think of it as a standard LLC, but with a twist: ownership is restricted to family members related by blood, marriage, or adoption. For your accounting firm, this could be the perfect blend of maintaining management control while gradually passing on the firm to the next generation.
One of the biggest advantages of a Family LLC is its limited liability protection. Unlike an FLP, where general partners are exposed, all members of a family LLC enjoy a shield between their personal assets and the firm’s liabilities. Flexibility is another key advantage. When you want to start stepping back, you can hire non-family managers to handle the daily operations. It’s a great way to ease into retirement without abruptly letting go of everything you’ve built.
The operating agreement of a family LLC is highly customizable. You can include provisions that restrict asset transfers, limit the ability to force out management or prevent certain members from making business decisions. As for taxation: like FLPs, family LLCs offer pass-through taxation and the ability to transfer shares at a discounted basis, potentially reducing your taxable estate, especially relevant with the TCJA sunsetting at the end of 2025.
Making the Right Choice for Your Accounting Firm
So, how do you decide between an FLP and a family LLC for your accounting firm’s succession plan? It’s not a one-size-fits-all decision. You need to weigh several factors:
First, think about your liability concerns. If protecting your personal assets is keeping you up at night, a family LLC might help you sleep better with its across-the-board limited liability protection. Next, consider how much control you want to maintain. If you want to remain involved in every aspect of the firm, an FLP might be more your style, as you will have direct authority as a general partner.
Then there’s your succession timeline. How quickly do you want to transition control to the next generation? A family LLC might offer more flexibility in this regard, allowing for a more gradual transition.
Of course, as a CPA, you’re probably already thinking about the tax implications. Both structures offer advantages, but which one will be most beneficial for your specific situation? This might be a good time to consult with a financial planning professional who specializes in business structures and succession planning. Lastly, don’t forget to research the regulations in your state. The rules surrounding FLPs and family LLCs can vary, potentially impacting how easy (or complex) it is to set up and manage your chosen structure.
The Best of Both Worlds?
The prospect of leaving your personal assets exposed in an FLP may not sound too appealing. Fortunately, it’s possible to minimize that risk by creating an LLC and naming it as a general partner in your FLP. However, this adds another layer of complexity to your business, including intricate tax and legal considerations, which require careful planning to ensure the benefits outweigh the additional complexities.
In Conclusion
Passing on the firm you’ve worked so hard to build to the next generation is one of the greatest dreams of successful business owners. However, without a firm plan in place, you could be unwittingly reducing the value of that dream, potentially placing your successors in peril. Every dollar counts – not just for your retirement but for the viability of your firm as well.
If you’d like to discuss what structure makes the most sense for your business and retirement goals, we’d love to talk with you. Don’t hesitate to reach out by clicking the button below.
