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
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
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
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
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
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
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
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
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
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
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
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
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
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.
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