Attorneys love to push Family Limited Partnerships for estate planning and asset protection purposes, generally because they are costly to prepare and involve a great deal of paperwork, but the real reason is that most people simply do not understand that like most any other profession these entities are just another way to generate business for the law firm and simpler methods exist to provide equal protection without the potentially negative ramifications and governance responsibilities.
Family Limited Partnerships (FLPs) are simply statutory Limited Partnerships, like corporations or LLCs, created by the filing of a formation certificate with a given state. These entities segregate control of assets and ownership of assets, i.e. in an investment setting a limited partner would contribute assets/funds to a venture and the general partner would manage the venture. In a business setting these types of entities are extremely useful for raising debt capital, particularly in a Reg D 506b or 506c type arrangement, but with family estate planning, these entities are generally too costly, too management intensive (due to the requirement that FLPs be run as separate entities), and for most people and do not provide any additional benefits to what simpler arrangements can do.
First off, personal assets such as residence-usually the most valuable asset most people own-the family vehicle, wages, retirement benefits, and personal property are generally protected by state laws from seizure by creditors, if not fully then up to a certain amount. Protecting the homestead is extremely easy; usually they are heavily leveraged by a mortgage and when paid off simply obtain a LOC from a bank on the equity to take out when threatened: there you go problem solved.
These personal assets can be easily passed on through probate by will or a living trust, where a successor trustee distributes these assets after the primary trustee and original owner of the assets passes away. Most states probate laws have been greatly simplified and obtaining ‘letters testamentary’ to change title to assets and transfer them is not a great difficulty which would outweigh the cost and difficulty of starting and managing an FLP. FLPs are costly to form, to manage and to file taxes as a partnership using a K-1 and 1065 which should be professionally prepared.
A commonly touted advantage of FLPs is the discounting of limited partnership interests transferred to family members which may indeed provide substantial tax savings. This simply means that the limited partnership interest’s value is reduced because of its reduced marketability and lack of control of the partnership, sometimes up to 50%. This type of reduction is closely scrutinized by the IRS and an audit becomes that much more likely, which may end up costing more than the tax savings achieved after years of transferring reduced interests to family. Nonetheless, such discounting rules also apply to the LLC entity, if you elect to utilize such a course of action.
In addition to this, transferees of limited interests are generally in a very low bracket so their full tax liability would not be very substantial in any case. However, it should be mentioned that transfers under the gift tax exclusion are a solid way to transfer FLP interests as no taxes are property owed by transfers within such limits as are annually proscribed by the IRS, but you don’t actually need an FLP to take advantage of the gift tax exclusion; owners can just as easily make such transfers directly from their estate without having to change title to the assets while forming the FLP. The estate tax exclusion right up to the annual limit can likewise be taken advantage of without having to form an FLP.
Asset protection is also stated as an enticing benefit of forming an FLP as creditors cannot go after the limited partnership assets; however, the creditor may obtain a charging order against the FLP which would entitle it to any distributions made to the debtor/defendant/general partner. In some states foreclosure of FLP interests is also available, meaning the interests are seized and sold on the open market with the creditor receiving the proceeds up to the judgment amount with the remainder going to the debtor. The interests sold would not be the actual partnership assets but the partnership interests which would entitle the new owner to the distributions made by the general partners.
In practice foreclosure is not a great remedy as it is unlikely that anyone would pay any substantial amount for interests which are not guaranteed to receive any distributions. There may and should also be provisions in the partnership agreement allowing the general partners to buy out any involuntary transfer purchasers at a greatly reduced price; this would greatly dissuade any 3rd parties from buying the interests. So while there are definite asset protection benefits to an FLP, they are not substantially different or greater than benefits of an LLC, for example. Further it should be mentioned that business assets should not be held in an FLP, they would need to be segregated from all other assets, with at least a single or double LLC structure, perhaps even greater, anonymized, and potentially leveraged with good debt, all in order to deter litigation.
In conclusion FLPs are generally overused and oversold by the legal profession in its quest for profit, much like the land trusts that were described in a prior post; there are far better ways to govern disposition of an estate using trusts, LLCs, offshore companies, and perhaps all three together. Future posts will describe how to form anonymous LLCs using a trust as member/manager and potentially utilize an offshore company-as necessary-to provide far superior asset protection and estate planning benefits with less expense and simpler management than the use of FLPs. Further, none of the entities described here will reduce taxes; they are generally tax neutral. If anyone tells you there are guaranteed tax reductions by use of any entity onshore or off, except for the risky discounting method described above, they are pulling your leg. Tax reduction is generally achieved through tax deferral by use of legal ‘loopholes’ which are available to anyone regardless of entity or legal structure, and you don’t need a 401k to take advantage of them.
Please don’t hesitate to inquire with this Firm regarding any questions on the above topics.