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.
 
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.

 
--------------------------------------------------------------------------------------------------------------------