Using a Family Limited Partnership to Lower Estate Tax Liabilities

In a previous post, I discussed the advantages of using a family limited partnership — or FLP — to help protect a family business and pass it down to the next generation. The benefits of FLPs are not, however, limited to the family business. The ability of family limited partnerships to lower estate tax liability makes them a valuable planning tool for larger estates, even in the absence of a family-owned business.

FLP Assets

An FLP can hold most asset types. There are some structural complications — for example, S corporation stock raises § 1361(b)(1)(B) shareholder-eligibility issues because a partnership is not a permitted S-corp shareholder — but an FLP may be used for much more than a family business. An FLP can hold the bulk of your wealth, if you wish, and pass it to the next generation as efficiently as possible.

Say, for example, that over the course of your life you and your spouse accumulate assets totaling $40 million in value — well above the 2026 combined federal estate-tax exclusion of $30 million for a married couple. These assets will be subject to the federal estate tax at death, so you want to remove as much as possible from your estate to help ensure that your heirs — not Washington — inherit the fruits of your labor. (Those fruits, it may be added, have already been taxed once — and if any of the wealth stemmed from corporate profits, twice.)

You cannot, however, simply give the money away while you are still alive: that would trigger the gift tax, a backstop tax designed to frustrate efforts to avoid the estate tax. (Charitable gifts are not subject to the gift tax, so charitable giving can and should be part of most estate plans.)

Gifts to your heirs, or anyone else, do trigger the gift tax, and so proper planning is necessary to make sure as much of your wealth as possible passes to your chosen heirs.

Family Limited Partnership to Lower Estate Tax Liabilities

The family limited partnership is a good way to do this. By forming an FLP and transferring assets into it, you can keep control of those assets by naming yourself — or an entity you control — the general partner, while gifting portions of your estate to your heirs through FLP limited-partnership units.

Gifts valued at $19,000 or less per donee per year are within the 2026 federal annual gift-tax exclusion and are not subject to the gift tax. (The exclusion is adjusted for inflation; in 2025 it was also $19,000.) Married couples can elect to gift-split, doubling that to $38,000 per recipient per year.

So, for example, if your children are your sole heirs and you have five children, you and your spouse together can gift FLP interests worth $190,000 per year ($38,000 × 5) without any gift tax consequences or use of the lifetime exclusion. That $190,000 escapes both the gift tax and eventual estate tax liability — and the figure compounds quickly when valuation discounts are applied.

Valuation Discounts

The process is sweetened, however, by valuation discounts. Because a limited-partnership interest in an FLP confers neither control of the entity nor easy marketability, the gift’s value is discounted from a pro-rata share of the underlying assets.

A 20% limited-partnership interest in an FLP, therefore, is not worth 20% of the entire FLP — often it is appraised at significantly less. Lack-of-control discounts of 15–25% and lack-of-marketability discounts of 25–35% are not uncommon, with combined discounts in the 30–40% range frequently sustained on audit when the partnership is properly formed and operated. That means a $19,000 annual gift can move significantly more than $19,000 of underlying assets out of the estate.

Tax-Free Growth

Once the interest is gifted, it can continue to appreciate in the recipient’s hands while remaining excluded from the donor’s taxable estate. This is where the FLP’s ability to lower estate-tax liability really compounds.

Over several years, a coordinated gifting program can transfer large amounts of wealth to heirs and mitigate — or eliminate — estate and gift-tax liabilities, all while the donor maintains operational control of the assets through the general-partnership interest.

Gifting Early

The FLP advantage compounds dramatically when the gifting program begins before the underlying assets appreciate. Transferring limited-partnership interests while a business is still small moves far more future value out of the estate than waiting until it has grown — the same structure imposed on a mature, billion-dollar enterprise is far less efficient. A married couple worth $10 million today might not feel the estate tax pressing, given the 2026 combined exclusion of $30 million, but the heirs of a business that later multiplies in value will be grateful the transfers happened early.

Consider Walton Enterprises. Sam Walton organized the family’s business interests as a family partnership in 1953 — nearly a decade before Walmart’s first store opened in 1962. By the time he died in 1992, the bulk of the Walmart fortune was already in his children’s hands, having been transferred when the underlying assets were a fraction of their eventual value. Setting up the partnership early was straightforward; attempting the same transfers after Walmart had become a multi-billion-dollar company would have taken centuries to accomplish what was easily done at the outset.

Section 2036 and the Limits of FLP Planning

FLP planning is not without risk. The IRS regularly challenges FLPs under IRC § 2036(a), which pulls back into the gross estate any property the decedent transferred but in which they retained “the possession or enjoyment of, or the right to the income from, the property.” Cases such as Estate of Strangi v. Commissioner, 417 F.3d 468 (5th Cir. 2005), and Estate of Bongard v. Commissioner, 124 T.C. 95 (2005), illustrate the recurring fact patterns that lead to a § 2036 inclusion: commingling personal and partnership funds, post-formation distributions tied to the donor’s personal needs, lack of a non-tax business purpose, and disregard of partnership formalities. Properly structuring and operating an FLP — ideally well in advance of any anticipated estate-tax exposure — is critical.

Using an FLP for estate-planning purposes can therefore be a somewhat complex matter requiring the guidance of a competent attorney.

Disclaimer: This post is for informational purposes only and is not legal or tax advice. FLP planning involves complex federal tax and state partnership law and is regularly challenged by the IRS. Consult a qualified estate-planning attorney about your specific situation.

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