FORM A FAMILY LIMITED PARTNERSHIP
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|OUR GOAL—YOUR Complete Satisfaction and UnderstandingOur goal is to provide each of our clients with as much information as possible about starting a Family Limited Partnership. As you will see as you review the following material, there is a lot of information to digest and consider. Many legal aspects may be complex and confusing. We want you to know we are available to speak with you about any legal aspects of the formation of your Family Limited Partnership at your convenience either over the telephone or in person at the Spiegel and Utrera, P.A., office nearest you. |
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What's a Family Limited Partnership?
The Family Limited Partnership (“FLP”)
is a limited partnership where family members hold most or all of the ownership interest in a limited partnership, and it is an important vehicle for asset protection and estate planning. The FLP can be used to create a powerful strategy for asset protection and for realizing estate tax and income tax benefits.
The FLP can be formed so that a husband and wife are each general partners that handle the day to day operations of the family business or perhaps by a husband and an older son. Also, the FLP has limited partners that invest, perhaps only nominally, in the FLP. Typically, the husband, wife and children are the limited partners.
After forming the FLP, all family assets can be transferred into it, including investments and business interests. After the transfers, rather than such assets being owned individually by the husband and wife, etc., the husband and wife will own a controlling interest in a business entity that owns the assets. The family members that are general partners will have complete management and control over the affairs of the partnership and can buy or sell any assets they wish on behalf of the FLP. Furthermore, as general partners the family members can decide to distribute the proceeds from the sale of the assets or for the FLP to keep such proceeds.
Asset Protection from Creditors
An important feature of the FLP is asset protection. If an individual is sued and the plaintiff gets a judgment against the defendant, the plaintiff/judgment creditor can seize everything owned by the defendant/debtor. If a husband and wife plan wisely and are partners in an FLP where all they transferred their formerly personal assets to the FLP, the only asset individually owned is the interest in the FLP. Such a creditor cannot reach into the FLP and seize the investments and bank accounts of the FLP. The creditor has no rights to any property held by the FLP. Since title to the assets is in the name of the FLP and it is an individual that is a partner rather than the partnership itself which is liable for the debt, the partnership assets may not be taken to satisfy the judgment.
A creditor may apply to a court for a charging order against an individual partner’s partnership interest. When this happens, in the event of an FLP distribution, instead of the money going to the individual partner, the money goes to the judgment creditor until the amount of the judgment is satisfied. Cash distributions paid to the partner/debtor could, therefore, be taken by the creditor. This doesn’t mean that the judgment creditor is a partner in FLP, it means the judgment creditor receives the right to any distributions paid to an individual partner/debtor.
The way to forestall such a scenario where a creditor has obtained a charging order is that the FLP should have provisions in its partnership agreement preventing distributions to the debtor partner. Since the partnership would not have any distributions, the judgment creditor won’t get paid, at least not from that collection method. Instead, the FLP would retain its funds and continue to invest and reinvest its money.
The Family Limited Partnership is an excellent vehicle for holding interests in other business entities. Because you want to protect your valuable family assets from creditors, you do not want the FLP to actively conduct business, as this will expose such valuable family assets to litigation. Instead, you want the FLP to own shares of corporate stock or membership interests in limited liability companies (“LLCs”). Such corporations or LLCs in turn will hold individual investment properties or conduct business with a specific business purpose. In this way, exposure to liability is isolated where litigation concerning one of your businesses will not jeopardize the other businesses and the assets they hold.
The FLP has tremendous flexibility. To that end, with family assets held by an FLP, it may be possible to obtain income tax savings by spreading income from high tax bracket parents to lower tax bracket children and grandchildren who are fourteen years or older.
The FLP can also be a vehicle for dramatically reducing or eliminating estate taxes by shifting the value of your assets out of your estate without any loss of control through a program of gifting limited partnership interests to your children or other family members. This is done with an estate plan including an FLP established to hold all of your family assets. Say for example you and your wife are general partners of the FLP. As such, you would have management and control over your property in the FLP. Initially, you could make a gift of the FLP interests to your children in an amount equal in value to the combined maximum estate tax credit (currently $2 million). Later, you could gift limited partnership interests equal to the amount of the annual gift tax exclusion of $22,000 per child ($66,000 per year).
The value of each gift of a limited partnership interest may be discounted in order to account for the lack of marketability and the lack of control associated with those interests. Instead, because the FLP interest cannot be readily sold and because the donee has no right to participate in management of the FLP, many financial advisors recommend discounting the transferred interest to reflect its true market value. Depending on the situation and estate planning aggressiveness discounts in the range of 30 to 50 percent may reduce the estate tax burden.
FLPs versus Family-Owned Dual Class LLCs
Generally speaking, a family-owned Dual Class LLC may achieve the same results as an FLP, insofar as multiple-member LLCs can be taxed as a partnership and the management and investment aspects can be isolated the same way as with an FLP. Also, instead of the general partner of the FLP either being exposed to liability (if a plain vanilla limited partnership, rather than a limited liability limited partnership) or facing the expense of forming a corporation or other entity that intrinsically has limited liability, all managing members will have their liability limited to the extent of the capital they have contributed in exchange for their equity interest. Furthermore, the Family Owned Dual Class LLC is considerably less expensive than the FLP. Finally, the Family Owned Dual Class LLC is extremely flexible, as it can be taxed as a partnership or a corporation, depending on what the members elect. However, it should be noted that because limited partnerships have been around for years, court cases involving limited partnerships allow planning to be more certain compared to the dearth of guidance for LLCs in general and Dual Class LLCs in particular. Thus, you will want to carefully analyze your situation and seek guidance from an attorney or other estate planning professional for the entity that best fits your family business situation.
Formalities Are a Must
Please be advised that in order to fully realize the asset protection and estate planning potential of FLPs, it is essential that all business formalities are followed and documented as if the FLP is a completely independent entity and that there are no family relationships involved, as courts and the Internal Revenue Service will carefully scrutinize the dealings of the FLP in order to disallow the tax benefits claimed by the partners of the FLP (see Kimbell v. U.S.A.
, Case No. 03-10529 (May 20, 2004 )). This means that all the financial and business records should be carefully maintained, that funds are not commingled, that any and all agreements are carefully drafted, that real property and other assets should be treated as FLP assets rather than personal assets, that transactions should be carefully documented and bona fide
rather than disguised gifts or sham transactions, that any price paid for in a FLP transaction is fair market value, that any transaction have a valid business purpose such as asset protection or continuity of family ownership rather than tax avoidance and that appraisals used to claim a valuation discount are adequately substantiated.
Careful drafting of FLP documents is crucial, and the partnership agreement of the FLP must contain certain key provisions designed to protect your valuable family assets from creditors of individual partners and that family members maintain control over the FLP.
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