How to Combine a Family Limited Partnership with a Trust: A Common US Family Structure

A surge in US state-level estate tax exemptions scheduled for sunset at the end of 2025 is driving a measurable increase in cross-border wealth structuring inquiries from Asian families with US situs assets. The Tax Cuts and Jobs Act (TCJA) of 2017, which doubled the federal estate tax exemption to USD 13.61 million per individual for 2024, is set to revert to approximately USD 7 million (adjusted for inflation) on 1 January 2026 unless Congress acts. For a Hong Kong family holding a USD 25 million US real estate portfolio via a Cayman entity, the difference in potential US federal estate tax liability is approximately USD 6.6 million — a 40% top marginal rate applied to the excess above the exemption. This imminent cliff has refocused attention on the Family Limited Partnership (FLP) combined with a trust, a structure that has been a mainstay of US estate planning for decades but remains underutilised by Asian families due to its complexity and the need for precise regulatory compliance. When executed correctly, the FLP-trust combination allows a family to consolidate assets, centralise management control, and achieve valuation discounts for transfer tax purposes, all while maintaining the structural integrity required by the Internal Revenue Service (IRS) under Chapter 14 of the Internal Revenue Code (IRC).

The Core Mechanics: How an FLP and a Trust Interlock

The fundamental architecture of this structure involves two distinct but interdependent legal entities: a Family Limited Partnership (FLP) and an irrevocable trust. The FLP serves as the operational holding vehicle for the family’s illiquid assets — typically real estate, closely held business interests, or alternative investments — while the trust acts as the long-term ownership and governance mechanism.

The FLP as the Asset Container

The FLP is a state-law limited partnership, typically formed in Delaware, Nevada, or South Dakota for their favourable charging order protection statutes and lack of state income tax. The general partner (GP) — often a limited liability company (LLC) owned by the senior generation — holds a 1% to 2% interest but retains 100% management control. The limited partners (LPs) — the trust and, initially, the senior generation — hold the remaining 98% to 99% of the economic interest but have no voting rights or management authority.

The critical feature is that the GP interest, being controlling, carries a premium for valuation purposes, while the LP interests suffer from two standard discounts: a lack of marketability discount (typically 20% to 35%) and a minority interest discount (typically 10% to 25%). The IRS, in Revenue Ruling 93-12, formally recognised that minority discounts are available for intra-family transfers, provided the structure is not a disguised gift. For a USD 10 million real estate portfolio, the combined discounts can reduce the taxable value of gifted LP units to approximately USD 6.0 million to USD 7.0 million — a direct reduction in transfer tax exposure.

The Trust as the Perpetual Owner

The trust is typically an irrevocable grantor trust — most commonly a Grantor Retained Annuity Trust (GRAT) or a Dynasty Trust — that holds the LP interests. The grantor (the senior family member) transfers assets into the FLP in exchange for LP units, then gifts those LP units to the trust. Because the trust is irrevocable, the assets are removed from the grantor’s estate for US federal estate tax purposes, assuming the grantor does not retain a prohibited interest under IRC Sections 2036 or 2038.

The trust’s terms dictate distribution and governance. For a Dynasty Trust, the trust can last for the perpetuity period allowed by the state — Delaware allows up to 110 years, while South Dakota and Alaska have abolished the rule against perpetuities entirely. This allows the family to lock in the valuation discount for multiple generations without triggering a new gift tax event at each generational transfer.

Regulatory and Tax Considerations for Asian Families

For a Hong Kong or Singapore family with US situs assets, the structure must navigate both US federal tax law and the specific regulatory frameworks of their home jurisdiction. The Hong Kong Inland Revenue Ordinance (IRO) does not impose estate duty (abolished in 2006), but the US estate tax remains a direct liability for US situs assets held by non-US residents.

US Estate Tax Exposure for Non-Resident Aliens

A non-resident alien (NRA) individual — defined under IRC Section 7701(b) as someone who is not a US citizen and does not meet the substantial presence test — is subject to US federal estate tax on US situs assets exceeding a USD 60,000 exemption. This is dramatically lower than the USD 13.61 million exemption available to US citizens and residents. For a Hong Kong family with a USD 20 million US real estate portfolio, the estate tax liability at death would be approximately USD 7.98 million (40% of USD 19.94 million). The FLP-trust structure can mitigate this by transferring the assets out of the individual’s estate during lifetime, but only if the transfer is a completed gift for US gift tax purposes and the grantor does not retain an impermissible interest.

The US-Hong Kong estate tax treaty, signed in 1997 and effective from 1998, provides some relief by allowing a prorated unified credit for Hong Kong residents. However, the treaty does not eliminate the need for careful structuring. The IRS, in CCA 201330033, clarified that an FLP formed by a non-US person is still subject to US transfer tax rules if the underlying assets are US situs.

The Section 2036(a) Trap

The most common pitfall for Asian families is inadvertently triggering IRC Section 2036(a), which brings the FLP assets back into the grantor’s estate if the grantor retains “possession or enjoyment of, or the right to the income from, the property” or the right to designate who will possess or enjoy it. The landmark Tax Court case Estate of Strangi v. Commissioner (T.C. Memo 2003-145) established that the IRS will scrutinise whether the FLP has a legitimate business purpose or is merely a testamentary device. For a Hong Kong family, the risk is heightened if the FLP holds a single-family residence used by the grantor, as the IRS may argue the grantor retained economic enjoyment.

To avoid this, the FLP must have a demonstrable non-tax purpose — such as asset consolidation, management centralisation, or creditor protection — and the grantor must not retain the right to receive distributions or control the trust’s distributions. The trust should be drafted with an independent trustee, typically a Hong Kong-licensed trust company or a US corporate trustee, to ensure the grantor does not have de facto control.

Practical Implementation: Steps for a Hong Kong Family Office

The implementation of an FLP-trust structure for a Hong Kong family office requires a multi-jurisdictional approach, coordinating US federal law, Hong Kong company law, and the specific rules of the chosen US state.

Step 1: Asset Identification and Valuation

The family office must first identify which assets are US situs and therefore subject to US estate tax. Real estate located in the US is always US situs. Shares in a US corporation are US situs, but shares in a non-US corporation holding US real estate are not — a distinction that matters for Hong Kong families using a BVI or Cayman holding company. The US Tax Court in Estate of Swan (T.C. Memo 2015-63) confirmed that the situs of shares follows the jurisdiction of incorporation, not the location of underlying assets.

A formal appraisal of the assets is required to establish the baseline fair market value (FMV) and to support the valuation discounts claimed on the gift tax return (IRS Form 709). The appraisal must be performed by a qualified US appraiser and must address both the lack of marketability and minority interest discounts.

Step 2: FLP Formation and Capitalisation

The FLP is formed in the chosen US state, typically Delaware or South Dakota. The partnership agreement must explicitly state the GP’s exclusive management authority and the LP’s lack of control. The family office contributes the US situs assets to the FLP in exchange for LP units. The GP interest is held by a newly formed LLC, which is owned by the trust.

The capitalisation must be done at FMV to avoid an immediate gift tax issue. If the family contributes a USD 10 million property in exchange for LP units worth USD 7 million (after discounts), the IRS will treat the USD 3 million difference as a gift. To avoid this, the family should contribute the property at FMV and then gift the LP units to the trust over time, using the annual gift tax exclusion (USD 18,000 per donee for 2024) and the lifetime exemption.

Step 3: Trust Drafting and Funding

The trust is drafted under US state law, typically Delaware or South Dakota for Dynasty Trust provisions. The trust must be irrevocable and must name an independent trustee. For a Hong Kong family, the trustee can be a Hong Kong-licensed trust company with a US corporate co-trustee to ensure US tax compliance.

The trust is funded by the gift of LP units. The grantor files a gift tax return (Form 709) reporting the value of the gifted LP units at the discounted value. The IRS has three years from the filing date to audit the return, and the statute of limitations runs from the date of filing, not the date of the gift.

The Role of the Family Office in Ongoing Compliance

Once the structure is established, the family office assumes a critical ongoing role in maintaining the FLP’s legitimacy and avoiding IRS challenges.

Annual Form 1065 Filing

The FLP must file an annual US partnership return (Form 1065) with the IRS, even if it has no income. For a Hong Kong family office managing the FLP, this requires engaging a US tax preparer who understands the partnership tax rules. Failure to file Form 1065 for three consecutive years can result in the IRS automatically terminating the FLP’s partnership status, collapsing the structure and triggering immediate estate tax exposure.

Distribution and Governance Discipline

The FLP must operate as a true business entity. The GP must hold regular meetings, document decisions, and maintain a separate bank account. Distributions must be made pro rata to all partners — the GP and the LP trust — in accordance with the partnership agreement. If the GP distributes cash only to the grantor’s trust, the IRS may argue that the grantor retained an economic benefit, triggering Section 2036(a).

The Tax Court in Estate of Schutt (T.C. Memo 2005-126) upheld the FLP structure because the partnership had a legitimate business purpose — managing a diversified investment portfolio — and the partners respected the entity’s formalities. The family office must ensure the same discipline is applied.

Actionable Takeaways for the Family Office

1. Act before the TCJA sunset. The current USD 13.61 million federal estate tax exemption per individual will revert to approximately USD 7 million on 1 January 2026 unless Congress acts. Families with US situs assets exceeding USD 7 million should initiate structuring in 2025 to lock in current exemption levels.

2. Use a Dynasty Trust in a state without a rule against perpetuities. South Dakota, Alaska, and Delaware allow trusts to last indefinitely, enabling the FLP valuation discount to be preserved across multiple generations without triggering a new gift tax event.

3. Engage a US tax counsel for the Section 2036(a) analysis. The IRS will scrutinise whether the grantor retained economic enjoyment. An independent trustee and a demonstrable non-tax purpose are non-negotiable.

4. File Form 1065 annually and maintain meticulous records. The IRS can retroactively collapse the FLP for failure to file. The family office must budget for US tax compliance costs, which typically range from USD 5,000 to USD 15,000 per year for a single FLP.

5. Consider a Hong Kong-licensed trust company as co-trustee. This provides onshore governance for the Asian family while ensuring US tax compliance through a US corporate co-trustee. The Hong Kong Monetary Authority’s (HKMA) supervisory framework for trust companies under the Trustee Ordinance (Cap. 29) provides a regulatory backbone that US trustees recognise.