Dallas W. Jolley
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Asset
Protection,
Family
Limited Partnerships & Limited
Liability Companies
Asset
protection planning involves a variety
planning techniques that can be as
simple as having proper liability
insurance to being as advanced as having
one or more offshore trusts. This page
will explain how to limit your liability
through creating and funding an entity
that can insulate your personal assets
from creditors. Most importantly, asset
protection planning must be done before
any liability or possibility of
liability is on the horizon. Planning
early and completely is the key to
proper asset protection planning.
What is a
"family limited partnership"?
A family
limited partnership (FLP) is a
partnership that has both general and
limited partners. The general partner of
an FLP has full control over the FLP
even if the general partner owns a small
percentage of the FLP. The limited
partners are passive investors and have
few rights in the partnership. Limited
partners have liability only for the
amount of money or property that they
contributed to the FLP. The general
partner, however, has unlimited
liability.
Does a
family limited partnership have
additional benefits?
Yes!
The
following are additional
benefits
of using a
family limited partnership:
1 - An
FLP can reduce the management costs
associated with multiple investments and
can increase investment returns by
adopting a
consistently applied investment
philosophy.
2 - It
can simplify annual giving, especially
for real estate and other assets that
may be difficult to give away on a
piecemeal basis.
3 - With
proper drafting, an FLP can prevent
family assets from going outside the
family.
4 - An
FLP may be used for asset protection.
5 - An
FLP can be more flexible than an
Irrevocable Life Insurance Trust for
purposes of making gifts.
6 - An
FLP can create initiative among children
and prevent large gifts from reducing
their incentive to work.
7 - Because
general partners control an FLP, there
is less likelihood of litigation among
family.
What are
some other advantages of the family
limited partnership?
The general
partner can distribute assets directly
from the partnership to the limited
partners at any time that he or she
decides the limited partners deserve or
need the money. A partnership can be
amended if all partners agree, unlike an
irrevocable trust, which cannot be
changed. A general partner can receive a
reasonable fee from the partnership for
managing the assets. Combined with a
GRAT, income can flow out to the general
partner only. Family limited
partnerships can also be used for
purposes of asset protection. Because
the laws in most states do not allow
creditors to take limited partnership
interests or force the partnership to
pay out money, creditors find it
difficult to satisfy judgments. People
concerned about creditors who may not be
legitimate use FLPs for this type of
planning. FLPs can provide
administrative ease and great economies
of scale because diverse assets can be
put into them and then can be managed
more effectively by the general
partners.
What is the
tax purpose of an FLP?
An FLP is one
of the most effective methods for a
person to make gifts to children,
grandchildren, or others. The reason
that an FLP is so effective is because
limited partners cannot force
liquidation of their holdings, they have
no power to force the general partner to
distribute the earnings of the FLP, and
they cannot give their limited
partnership interests away or sell them
without the permission of the general
partner. Thus the value of the limited
partnership interests is subject to a
discount when calculating the fair
market value of these interests.Here is
how an FLP usually works: Ellen and
Joseph Barnes want to give their
children and grandchildren a parcel of
real estate that is worth $1 million.
Ellen and Joseph would like to retain
control of the property and not pay gift
tax to make the transfer. They form the
EJB Limited Partnership. Ellen becomes a
1 percent general partner, and Joseph
becomes a 1 percent general partner.
Each of them becomes a 49 percent
limited partner. Ellen and Joseph then
give each of their three children a 20
percent limited partnership interest,
and they give each of their two
grandchildren a 5 percent limited
partnership interest.After the gifts are
made, Ellen and Joseph still have full
control because they are the general
partners. The children and grandchildren
own a total of 70 percent of the FLP,
but have no control and cannot give away
or sell their limited partnership
interests. Even though Ellen and Joseph
made a gift of $700,000--70 percent of
the value of the real estate for gift
tax purposes--the gift tax value of the
gift was much less. Because the limited
partnership interests were subject to so
many restrictions, their value was
discounted by almost 40 percent by the
appraiser hired by the Barnes. For gift
tax purposes, the amount given away was
only $420,000. When either Ellen or
Joseph dies, their limited partnership
interests will likely be subject to
discounts in their estates.To the extent
they have made gifts, the future
appreciation of the real property and
other assets in the FLP will go mostly
to the children and grandchildren; the
FLP has helped slow the growth of the
Barnes's estate.
How great
are family limited partnership
discounts?
The generally
accepted discounts run as high as 40
percent. However, there are instances in
which discounts of larger amounts have
been much higher. The amount of the
discount depends on the terms of the
partnership agreement, the type of
property put into the partnership, and
to whom gifts of limited partnership
interests are given.
For example,
it is possible to get greater discounts
if some of the limited partners are not
related to the general partner. Caution:
It is imperative that an appraiser who
has solid credentials in the appraisal
of family limited partnerships for
purposes of federal estate and gift tax
be used to determine the amount of the
discounts in the FLP. An inadequate
appraisal will jeopardize the benefits
derived from using an FLP for estate
planning.
What are
some of the pitfalls to the family
limited partnership?
A key
ingredient to a legitimate FLP is that
it must have a business purpose. Just
using an FLP as an estate planning
discounting device or a creditor
protection plan is not legitimate.
However, managing a portfolio of
securities or some real estate property
is considered acceptable. The cost of
setting up an FLP can be relatively
high, and the administration costs can
also be high. Aside from needing a
lawyer to draft the partnership
agreement, you have to pay a valuation
expert to appraise the assets for
discounting purposes and you may be
required to pay filing fees to the
state.
Who should
not create a family limited
partnership?
FLPs don't
work well for people whose main asset is
their primary residence. If you transfer
your home into your partnership, you
don't own it anymore. To maintain the
estate and gift tax benefits, you have
to pay rent to the partnership to live
in it. Also, people with smaller estates
may not want to create an FLP because
the cost does not justify the benefit
derived. FLPs are sophisticated gift,
estate, and asset protection tools. They
are complex and need to be established
by very experienced advisors. If you are
not willing to do a complete FLP plan
with the best advice available using
excellent advisors, an FLP is not for
you.
Limited
Liability Companies
Limited
Liability Companies ("LLC") can provide
most the advantages of the family
limited partnership. Most commonly, we
recommend establishing an LLC as the
entity to own your real property
holdings. Call today to schedule your
free consultation to discuss asset
protection planning, and go the the
Brochures and Questionnaire page and
read the article about family limited
partnerships, and review the
questionnaire you should bring with you
to your appointment.
IRS CIRCULAR
230 DISCLOSURE
To ensure
compliance with requirements imposed by
the IRS, we inform you that, unless
expressly stated otherwise, if any U.S.
federal tax advice contained in this
communication, (including any
attachments) is not intended or written
to be relied upon or used, and cannot be
relied upon or used, for the purpose of
(i) avoiding penalties under the
Internal Revenue Code or (ii) promoting,
marketing or recommending to another
party any transaction of matter
addressed
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(253) 565-9300