How does a family limited partnership work, and what are the risks?
Discounts hold only with real substance and no retained control
A family limited partnership holds family assets, and gifts of limited partner interests may be valued with discounts for lack of control and marketability. IRC §§2703 and 2704 disregard certain restrictions in valuing those interests, and IRC §2036 can pull the partnership's full undiscounted assets back into your estate if you keep control or enjoyment, as in Estate of Powell, 148 T.C. 392 (2017).
Reviewed by Ebot Mbi, CPA, EA · Last reviewed · Law and figures current as of September 17, 2026
Key takeaways
- Discounts must come from a qualified appraisal of the actual partnership terms.
- §2703 disregards options and restrictions that fail its bona fide business arrangement, non-device, and arm's-length tests.
- §2704(b) disregards family-removable liquidation restrictions that are more restrictive than state law.
- §2036 is the main risk: retained enjoyment or control, including as a general partner, can bring the full undiscounted value back into your estate.
- At a $15,000,000 exemption, a discount preserves exemption. It saves estate tax only if your estate would otherwise exceed the exemption.
What it is
A family limited partnership (FLP), or a family LLC, is an entity that family members form to hold investment assets or a business. Parents typically contribute assets and then give or sell limited partner interests to children or to trusts. A limited interest cannot control distributions or force a liquidation and is hard to sell, so an appraiser may value it below its share of the underlying assets.
The partnership can also have non-tax purposes: centralized management, keeping assets together, creditor considerations, and a structure for bringing the next generation in.
What the law says
IRC §2703(a) provides that property is valued without regard to options or agreements to acquire it at less than fair market value, or restrictions on the right to sell or use it. Under §2703(b), a restriction is respected only if it is a bona fide business arrangement, is not a device to transfer property to family for less than full consideration, and has terms comparable to arm's-length arrangements.
IRC §2704(b) provides that when an interest is transferred to a family member and the family controls the entity, an "applicable restriction" on liquidation that is more restrictive than state law and that the family can remove is disregarded in valuing the interest (see Treas. Reg. §25.2704-2).
IRC §2036(a) includes in your gross estate property you transferred while keeping the possession or enjoyment of, or the right to the income from, the property, or the right, alone or with anyone, to designate who enjoys it. The exception is a bona fide sale for adequate and full consideration. In Estate of Powell v. Commissioner, 148 T.C. 392 (2017), the Tax Court included partnership assets under §2036(a)(2) because the decedent, acting with other partners, could dissolve the partnership.
Requirements and tests
- A legitimate and significant non-tax reason for forming the partnership, documented at formation.
- Contributions are credited to capital accounts, and the entity is funded with assets it actually manages, not your home or the cash you live on.
- You keep enough assets outside the partnership to live on and do not use partnership assets personally.
- Distributions are pro rata and follow the agreement; formalities, books, and separate accounts are maintained.
- Your retained powers are limited. Having you serve as sole general partner with broad control increases §2036 risk.
- Each gift is valued by a qualified appraiser and reported on Form 709 with adequate disclosure.
How it works
You form the partnership, contribute assets, and give limited interests over time. The appraiser values each interest based on the agreement, the assets, and market data. The gift tax value of each interest is its discounted value, so you use less lifetime exemption. In 2026, the basic exclusion amount is $15,000,000 per person, so most gifts use exemption rather than generate gift tax.
At death, your remaining interest is also valued with applicable discounts, provided §2036 does not apply. If it does, the estate includes the full value of the underlying assets you contributed, not the discounted interest.
Annual operations matter as much as formation. The partnership should keep its own bank and brokerage accounts, file Form 1065 and issue Schedules K-1, hold meetings or written consents as the agreement requires, and make distributions only as the agreement allows. Courts have looked at these facts closely when deciding whether the parties actually respected the partnership.
Assumptions: Gift in 2026 by an unmarried donor with no prior taxable gifts; basic exclusion amount $15,000,000.; The limited interests represent $10,000,000 of underlying assets; a qualified appraiser applies a combined 30% discount (assumed; the actual discount depends on the facts).; For the estate tax line, the donor's estate is assumed to exceed the exemption, so each additional dollar is taxed at 40%.
| Undiscounted value | $10,000,000 |
|---|---|
| Discounted gift value | $7,000,000 |
| Gift tax due in 2026 (within the $15,000,000 exemption) | $0 |
| Exemption preserved by the discount | $3,000,000 |
| Estate tax value of the preserved exemption at 40%, only if the estate exceeds the exemption | up to $1,200,000 |
| If §2036 applies at death | Full undiscounted value of the assets included in the estate |
The discount preserves $3,000,000 of exemption; it reduces estate tax only if the estate would otherwise exceed the exemption and §2036 does not apply.
Illustration only; not a projection of your results.
Risks and IRS scrutiny
The IRS examines FLPs closely; the Internal Revenue Manual includes a lead sheet for family limited liability entities. Common failures include deathbed formation, commingling, paying personal expenses from the partnership, contributing nearly all of your assets, non-pro-rata distributions, and discounts not supported by the agreement or the appraisal. Consequences include estate inclusion under §2036, reduced discounts, and valuation misstatement penalties under §6662.
Who it is not for
This is not for estates comfortably under the exemption, for anyone who wants to keep using the assets as before, for anyone unwilling to follow the partnership agreement and formalities, or for anyone whose main reason is the discount.
How ebotCPA helps
We review the partnership's operation the way an examiner would: capital accounts, distributions, personal use, and retained powers. We coordinate the appraisal, prepare Form 709 with adequate disclosure, and model the exemption and estate tax effect. We coordinate with your attorney, who drafts the legal documents.
Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.
We coordinate with your attorney, who drafts the legal documents.
Frequently asked questions
What discount do family limited partnerships get?
There is no set percentage. A qualified appraiser determines discounts for lack of control and marketability based on the actual agreement and assets, and §§2703 and 2704 can disregard certain restrictions.
Can I be the general partner of my FLP?
You can, but retained control increases the risk that §2036 includes the partnership's full undiscounted assets in your estate, as in Estate of Powell (148 T.C. 392 (2017)).
Do I need an FLP if my estate is under $15 million?
Usually not for federal estate tax, since the 2026 basic exclusion amount is $15,000,000 per person. There may be non-tax reasons, which your attorney can evaluate.
Do I have to file a gift tax return for FLP gifts?
Yes, for gifts above the annual exclusion, and filing with adequate disclosure of the valuation starts the statute of limitations on the gift's value.
Have facts like these?
Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.