The Family Limited Partnership can provide a solid layer of defense between your assets and creditors. Once you have established an FLP, creditors pursuing the assets in the business are difficult. Should a creditor be awarded a judgment there is a specific court ruling that must take place in order to endeavor to receive distributions of profit from the partnership. Even if the creditor receives a charging order, that does not guarantee that the creditor will be paid any amount toward the debt, but rather places the creditor in a position of becoming a receiver of income, whether profits are recognized or not. The money is not distributed to the creditor, yet the creditor must pay taxes on the income derived.
The FLP is one of the most effective tools for asset protection. It helps to reduce estate and income taxes, gives the ability to manage assets while simultaneously denying creditors access to the asset.
General partners have the majority of control while limited partners have little or no control. The law rebuffs creditors’ rights to obtain interest in the partnership. FLP’s insulate your assets from lawsuits and help you to retain control over your assets. FLP’s are used to protect real estate, stocks & bonds, cash, jewelry, furniture and fixtures and any other personal and business assets. The FLP is a tax neutral entity. Unlike a corporation, you can freely transfer assets in and out of the Family Limited Partnership without concern about an adverse tax effect.
Establishing an FLP
The first step to take is to properly establish an FLP based on the needs of the client. The partnership agreement must be drafted accurately and ownership determined. Assets must be legally transferred into the FLP. Once this is done, your assets are protected. The FLP must be filed with the proper state official, usually the person who handles corporations. Check with your state division of corporations to determine the requirements and fees required for proper filing.
How it works
If a judgment is obtained, a creditor must then acquire a charging order against the partnership from a court of competent jurisdiction. The charging order entitles the creditor to the debtor’s portion of distributions from the FLP. However, if no distributions are made, the creditor does not get any money. The general partners who are the managing partners of the FLP remain in control of any distributions. If the partnership has profits that are not paid to the partners, the creditor receives a K-1 tax form as does every partner. The amount listed on this tax form must be included on the creditor’s income tax return and pay any tax to the IRS on money that was never received. As a consequence, few creditors ever apply for a charging order. The partnership agreement is confidential and is not filed with any government agency. The limited partners are not listed in any government filings so complete anonymity is provided.
Implementation and Design
A Family Limited Partnership (“FLP”) is a partnership formed by family members to assist in the preservation, management, and maximization of the family’s assets. The partnership is typically managed by a family corporation to ensure the viability of the partnership for subsequent generations. FLPs can provide solutions to many of the fundamental challenges families are confronted with, such as:
• Proper administration of family assets during the lifetime of the senior family members
• Capitalize on the full value as the assets are passed on to heirs
• The reduction of current income taxes
• Reduction of the taxable value of the family’s estate
• Assisting in gifting of assets to family members
• Safeguarding family assets from the unwarranted assertions of creditors
Organization of an FLP
In an FLP, the assets of a family are contributed to the partnership in return for limited partnership units. The division of the units is generally amongst the family members who are the limited partners and one or more corporations, LLCs, or trusts that own the greatest number of units as general partners. The general partners are the management portion and the limited partners do not have any say in the operation of the business. The partnership will pay to the general partners fees for services rendered. Those fees are deductible by the partnership and in turn are income to the general partner. Any typical business expenses of the partnership are allowable under IRS regulations as with any business.
Income Tax Advantages of a FLP
Once properly prepared and with the consent of the general partner or as determined by the Partnership Agreement, any of the units held by any limited partner can be gifted to family members, be purchased by a trust in exchange for a note, or donated to a charity in any fashion desired. If donated to a charity, the grantor will receive an income tax deduction for the fair Market value of the gift. Keep in mind that not all choices are necessary or advantageous to the limited partners, therefore proper advice from experts in the field may be needed.