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The Family Limited Partnership: Giving it away but maintaining control

The Family Limited Partnership
Giving It Away but Maintaining Control

Introduction

How do you stay in control of assets, make gifts to your family, lower income and estate taxes, and avoid lawsuits? The Family Limited Partnership is being used by people all over America to protect, leverage, and control family wealth. Here’s how it works and what it can do for you.

Many of our clients have a need for retirement income planning, asset management assistance, the need or desire to avoid estate tax, and a desire to effectively lower income taxes by spreading income among family members in lower tax brackets. They may also want to involve family in management or beneficial enjoyment of family assets or a business to a greater degree, without surrendering total control. They can accomplish all of these objectives with a Family Limited Partnership, which we also refer to as an FLP.

A family limited partnership, for estate planning purposes, is a personalized gifting tool. Our clients transfer real estate or security investment assets into this specially drafted limited partnership. In fact, any investment grade asset may be transferred into the partnership. Parents, children, and even grandchildren can serve as the partners, either general or limited. You can also set up trusts to own partnership shares.

Usually our clients are the parents in the family creating an estate plan and using their own assets. They usually serve as the sole General Partners with the same powers of management and control over their assets they have always had. They and their children will become Limited Partners. An irrevocable trust may also be set up for the benefit of minor grandchildren if they desire to add them as limited partners in the future, since children who are not sufficiently mature cannot exercise their own legal rights.

Asset Protection

An FLP can protect assets from creditors in a lawsuit! With an FLP, when a judgment is entered against a partner the creditor has no right to seize the assets inside the partnership. Creditors have no right to manage the partnership or to demand that distributions be made from it. Partnership law generally provides a creditor with only one way to collect his judgment: a charging order. A charging order allows the creditor to seize any distribution from the partnership actually made, but not the assets inside it. Furthermore, since the creditor does not become a partner, there is no way for the creditor to force the general partner to do anything. He would be forced to wait until a distribution was actually made to the debtor-partner.

Sometimes, the partnership permits the General Partner to discontinue making any partnership distributions to a partner, for the reasonable needs of the partnership. This would increase that partner’s capital account, but other partners may still get distributions. Moreover, under IRS rules, even though a creditor doesn’t receive payments from the withheld partnership share, he is required to pay all the income tax associated with that share!. This leaves the creditor in the unenviable position of paying taxes on money he will never
receive. You now have a negotiation opportunity for settling the issue with the creditor.

The one caveat here is when a judgment is entered against the partnership itself. In that event, the creditor may satisfy his judgment with partnership assets, including insurance. If that is not enough, then the General Partner is personally liable. If this is a concern, then we make sure that we use a corporation, a trust, or some other business entity as the General Partner, and not our clients personally!

Protecting General Partners

Usually, our clients serve as the General Partners. When a potential lawsuit against the partnership is itself a concern, a greater degree of asset protection is required. This is because a General Partner remains liable for the unsatisfied liabilities of the partnership (not of individual partners, though). In order to cut off this kind of liability, we can structure a corporation, irrevocable trust, or a limited liability company to serve as the General Partner. This technique reduces the personal risk to our client for partnership debts or liabilities.

Additional Tax and Family Benefits

There are powerful tax and personal reasons, potentially far more important than lawsuit protection, for setting up an integrated estate and asset protection plan. The following is a brief summary of some of these legitimate business purposes:

Gifts to Family Members Made Easy

One of the primary benefits of the partnership is its ability to maximize annual tax free gifts to family members. Current law taxes estates greater than $5.34 million at rates beginning at 40%.

Gifting to family members while the parents are alive reduces the estate, but causes a loss of control, and may take too long. At present, each person may transfer $14,000 tax free per person each year, or $28,000 for married couples. Some people don’t want to give up control of the asset while they are alive, or don’t have sufficient disposable cash on hand to give away. They don’t know how to make gifts of partial interests in other property.

The Limited Partnership allows you to make annual gifts of limited partnership interests either directly to your children or grandchildren, or to a trust set up for their benefit. You can make the gift any size they want without informing the IRS, up to $28,000 (or $14,000 from each parent) per child per year by simply transferring a partnership interest of that dollar amount. Since you convey only a limited partnership interest and not the asset itself, you stay in control!

Remember, you are the General Partner.

If you want to involve your family in management, the General Partner may be a child, business associate, limited liability company, corporation or even a trust! As the years go by, children and grandchildren can begin to accumulate an equity interest within the partnership, which can be used for education or other needs. You can hold on to their income so it will grow until they need it or you are ready to distribute it, although you should distribute annually enough income to pay income tax attributable to each partner.

Income Tax Burden Shifted to Other Family Members

Children and grandchildren can participate in the growth of all assets in the partnership at income tax rates which should be lower than yours. Let the government help you out! You get a net reduction of the cost to provide for the education and certain other needs of the family.

Family Members are Entitled to Reasonable Salaries

Family members who manage, or who provide services for the partnership, can be paid for their help. Again, this gives you control over the size of partnership distributions, and the manner in which they are actually received.

Easier to Make Family Loans

The General Partner may make loans permitted by the partnership agreement. You maintain control and access to your funds for the benefit of your family. When family members need distributions for specific needs, such as education, and their capital accounts are not sufficient, loans can be made and paid back at a later date. The loan can be repaid in future years from subsequent distributions.

Both Spouses Will Manage Family Finances

Spouses, if both are General Partners, will be responsible for the business of managing the investments in the partnership. In the event either of them should become disabled or die early, the other will be fully equipped to carry on the operation of the partnership. You can also use a management trust designed to cover such a contingency, and provide personal instructions to your successor.

Maintains Privacy

The details of investment activities and the nature of the partnership assets themselves are not in the public record. Only a Certificate of Limited Partnership is filed with the state, which contains some information required by the state, which may incidentally frighten off creditors!

Estate Will be Organized at Death

A partnership, particularly used within the context of the estate plan, provides you an opportunity to remain organized. The partnership must file a yearly tax return with an accompanying balance sheet. By knowing what there is, where it is, and what it’s worth, countless hours of personal and professional time can be saved.

Family Can Work Together

Use your partnership to train the younger generation. The more you get them involved, the better.

While they may not participate in management, you can certainly pass on your philosophy and ideals, along with the shares you gift or income you distribute. People, particularly children, with an equity stake through their partnership interest take a greater interest in what goes on. This can be a valuable tool in keeping the family together. Our clients generally have a partnership business meeting during the holidays, where they review the business year and distribute income or make gifts of partnership shares.

Effective Investing

Pooling of assets means that management costs may be reduced, and may achieve better rates of return. It is also easier to manage your assets if they are collected rather than scattered. You can negotiate preferential treatment with your broker or financial advisor when you have more to offer! You can also diversify without fear that you will lose control.

Prevents Use of Joint Tenancy Title

Use of the partnership can prevent the inadvertent use of joint tenancy with right of survivorship (JTWROS) on bank accounts and brokerage accounts. Joint tenancy is an unwise way to hold title to assets for a variety of tax and estate planning reasons. It can completely frustrate the distribution of an estate. Holding title in the name of the partnership can effectively thwart the unintended use of joint tenancy.

Estate Tax Discounts With Limited Partnership

One of the most important benefits of the limited partnership is a discount in the size of the taxable estate at death. The IRS values all assets owned by the decedent at the time of death using a fair market value formula, which means what a willing buyer will pay a willing seller under non-coercive business circumstances. The valuation process is very favorable to the taxpayer when a limited partnership is involved. Because almost all of the decedent’s partnership interest has been designated as limited partnership shares, the question at death becomes: What is the fair market value of a Limited Partner’s interest?

The Agreement itself limits the economic value of a share of the limited partnership. Since a Limited Partner has no right to demand a distribution, order a dissolution of the partnership, or in any way participate in the management of the business, the Limited Partner’s interest is not as valuable since they lack the rights of a full owner. Nobody would buy your interest from you and pay full value for such a restricted partnership interest. Therefore, your limited partnership interest is discounted to a more reasonable fair market value at death to reflect this reality. Cases abound throughout the land illustrating this point. For example, in one estate the family saved $14,000,000 in estate taxes by qualifying for a $26,000,000 reduction in value! While your savings may not be as great, every dollar is saved for your family.

Your Partnership Agreement Is Dependable and Can be Customized

Limited partnerships have a long legal history, and are recognized in every state. U.S. limited partnership law, while it has evolved, has in many respects remained essentially unchanged for decades. You can safely use partnership law to plan for your family.

Your personal goals will dictate our design. While limited partnerships are common in the marketplace of American business and participate in almost all commercial business ventures, a family limited partnership contains specific provisions for you.

Irrevocable Children’s Trusts

Trusts for the benefit of minor children or grandchildren may be created to hold partnership shares. These irrevocable trusts can be named as limited partners of the limited partnership to provide you with a way to shift income and assets to lower tax rate beneficiaries. Each trust has an independent Trustee who is in charge of management of the assets until a child reaches an age when the trust directs distribution of assets. Since the trust controls all limited partnership shares gifted to it, there would be no problem of trust assets being dissipated before the trust distributes them.

The value of the partnership interest transferred to children or grandchildren will not be counted as a part of their estate for estate tax purposes, for probate or for creditor claims. All distributions to children or grandchildren will be taxed at their (potentially lower) income tax rate. This shifting of income can provide substantial income tax relief.

Summary

The Family Limited Partnership is your opportunity to dramatically lower your lawsuit exposure, income and estate taxes, and gain better control over your assets. You can be creative with it, and help your family to work and benefit together.

Our planning team is dedicated to assisting you in using these tools properly! It does take time, effort, and significant technical expertise, just as it took you time and effort to build your family and your estate. Please contact our firm to discuss your own estate planning opportunities without delay.