WHAT PROTECTION IS AVAILABLE THROUGH A FAMILY LIMITED PARTNERSHIP? A Family Limited Partnership (”FLP”) is a limited partnership that is formed to manage and control jointly-owned family property. All the requisites of a limited partnership must be followed in order to have a valid FLP. Upon formation, the assets of the family are assigned or transferred into the FLP for ownership, management, and control. In most FLP’s, the parents are the general partners with a 1% interest, while the children and siblings share the remainder as limited partners. Thus the parents’ exposure to risk of loss of property held by the FLP is greatly reduced. Even if a charging order is obtained by a creditor, the partnership can limit distributions (for legitimate purposes) to reduce exposure. An FLP also can have a dramatic effect on gift and estate taxes. By transferring assets to a FLP, general partners can use valuation discounts to lower values. With lower valuations, the amount of tax imposed can be substantially reduced. WHAT IS A LIMITED PARTNERSHIP? A Limited Partnership (”LP”) is an association of one or more general partners together with one or more limited partners to conduct business for profit as co-owners. The most important feature of a LP is that the limited partner enjoys limited liability as long as he/she does not participate in the control of the partnership business. The general partners of the LP are the ones who are responsible for the obligations of the LP. In a limited partnership, it is the general partner who remains liable for the debts and obligations of the entity. For larger risk exposure, a corporation may be formed to serve as the general partner. A corporate general partner is protected from direct attack by a judgment creditor because the ultimate liability for the debts and obligations rests with the shareholders. By spreading share ownership, individual exposure is considerably reduced. Even without a corporate general partner, risk can be spread by distribution of limited partnership shares. If a judgment creditor obtains a charging order against one partner, the order goes to that partner’s share in distributions from the partnership, and not to the entire business. FAMILY LIMITED PARTNERSHIPS What is a Family Limited Partnership? A Family Limited Partnership is an entity, like a corporation. It is used to protect assets and keep them in the family. A certificate is filed with state authorities to bring the partnership into existence. The Partnership has a distinct identity and a tax identification number. It can own assets and can conduct most activities that can be conducted by an individual or a regular corporation. Who owns a Family Limited Partnership? Partners own it. General Partners have a percentage of ownership and can generally control and manage the partnership. They can make investment decisions and decide when and how much to distribute to Partners. A General Partner can be held responsible for any liabilities that the Partnership may have. Limited Partners have a percentage of ownership but have no voting or management participation rights. A Limited Partner should not have personal liability for any activities of the Partnership, much like a shareholder in a corporation is protected from any corporate liabilities. Typically, for example, a father would put assets into a Family Limited Partnership. He would own, say, 50% of the Partnership as General Partner. He could then gift 50% of the Partnership to his children by giving them Limited Partnership interests. He would thus control the partnership, but 50% of the assets and all income and growth thereon would be owned by his children. Why is a Family Limited Partnership a preferred structure for intrafamily gifting and ownership? There are may advantages to using Family Limited Partnerships. The advantages include: 1. Controlled Distributions - The General Partner can control the Partnerships and its distributions. Income and profits from the Partnership do not have to be distributed; they can be reinvested. 2. Restrictions - Limited Partners can be restricted from transferring, selling or otherwise “losing” their ownership interest. 3. Valuation Discounts - A discount can be used in calculating the value of Limited Partnership interest given to family members. For example, a 10% interest in a $1,000,000 Limited Partnership may be valued substantially less than $100,000 for gift tax purposes. Gifts of Partnership interest can qualify for the $10,000 per year annual exclusion if structured properly. 4. Creditor Protection - A certain degree of creditor protection is inherent in owning interest in a Limited Partnership. A Limited Partner’s creditor(s) cannot directly levy upon Partnership assets and cannot “take” a Limited Partner’s interest in a Partnership. Current law only allows for a “charging order” which requires that any monetary or financial distributions from the Partnership to a particular partner be given to that Partner’s creditor(s). The response to such an order can be that the Partnership simply reinvests earnings instead of making distributions. 5. Arbitration to Settle Disputes - A Family Limited Partnership Agreement can provide an arbitration provision to resolve any family disputes among Partners. The Partners simply agree in advance to have any disputes resolved by arbitration. The use of arbitration can avoid unwanted publicity or a possibly negative outcome in a jury trial that could otherwise be used to resolve disputes. There can also be a provision in the Partnership Agreement whereby a Limited Partner who brings an unsuccessful arbitration action against a General Partner would bear all costs of arbitration. This type of provision deters Limited Partners from bringing any frivolous or harassing actions against the General Partner. 6. Buy-Sell and Right of First Refusal - A Partnership Agreement can include buy-sell and right of refusal provisions to prevent unwanted persons from becoming Partners. A buy-out provision can provide that Partnership interest may be bought by other Partners or the Partnership at Fair Market Value or at a discount. 7. Asset Protection in the Event of Divorce - In the event a Limited Partner has a failed marriage, the Family Limited Partnership can be structured to protect assets and keep them in the family. The Partnership can be used as a means to segregate the spouse’s property. Most courts are reluctant to award a Partnership interest to the other spouse in a divorce proceeding. In the event that the court does award a Partnership interest in a divorce proceeding, such events could trigger a buy-out provision which would enable the Partnership interest to remain in the family. 8. Flexibility - Unlike an Irrevocable Trust, a Family Limited Partnership can be very flexible. A Family Limited Partnership may be amended or terminated if all of the members agree to do so. 9. Reduced Costs - Placing all assets into a Family Limited Partnership can reduce administrative costs. There are less costs involved with placing all family assets in an entity or trust than placing assets in several trusts. How can I benefit from “minority discounts” on gifts? Family Limited Partnerships are an excellent gifting vehicle because children or beneficiaries can be given Limited Partnership interest that restricts their right to participate in management or financial decisions. The IRS has allowed “minority discounts” of up to 40% on Limited Partnership gifts due to their lack of control and marketability. The impact of these discounts can be best illustrated by this example. Assume that John Doe has $1,200,000 in assets and three children. Upon his death, assuming that no Family Limited Partnership was established, John’s estate would incur an estate tax of $235,000 and $965,000 would go to his beneficiaries. Using a Family Limited Partnership, assume that John gifts $50,000 per year to the Family Limited Partnership for 10 years. With the 40% “minority discount”, John can gift assets worth $50,000 per year into a Family Limited Partnership for the benefit of his children while only using $30,000 worth of annual exclusions. Using a Family Limited Partnership removes $500,000 plus any future growth on these assets from his estate. Upon his death, the estate tax would be $37,000; a savings of almost $200,000. Minority discount estate tax savings cab be even more drastic if a client can gift all or part of their $600,000 unified credit. For instance, if one was able to gift $1,000,000 to a Family Limited Partnership and take a 40% minority discount, the gift would only use their $600,000 unified credit while removing $1,000,000 of assets, plus any appreciation thereon, from their estate. How is a Family Limited Partnership taxed? A Family Limited Partnership is typically taxed like a regular partnership whereby all income and deductions flow to the partners pro rata, based upon their Partnership interest. This can be altered by agreement, and certain tax laws may effect the income and deductions that flow through to each Partner. The Partnership must file tax returns with the Federal Government and distribute K-1’s to the individual Partners so that their share of the income and deductions of the Partnership can be shown on their individual 1040’s. Unlike a regular corporation, there is no tax imposed on a Limited Partnership and, unlike an S Corporation, there is generally no tax when assets are conveyed from the entity to its partners. Limitations that apply to S Corporation ownership do not apply to Family Limited Partnerships. What are possible complexities that should be addressed by a tax advisor? Some of the complexities that must be addressed when establishing a Family Limited Partnership include making sure that the Partnership Agreement is carefully drafted so the Partnership is qualified as such under Federal tax law, and that income and expenses of the Partnership are properly allocated between the General and Limited Partners. The General Partner must also be “adequately capitalized” according to state creditor law regulating partnerships. It is definitely advantageous to use proper planning to avoid potential tax complications. What does it cost to form, fund and maintain a Family Partnership? Formation and maintenance costs are minimal compared to tax savings and overall security. In addition to legal fees, there are state registration fees. Partnerships formed using Delaware or Colorado law have out-of-pocket costs of less than $500. Not many of these partnerships are formed using Florida law because Florida charges 0.7% of 1% of the value of the assets used to form the Partnership, and then a specified amount per year to maintain the partnership. The Florida Department of Revenue regulations indicate that a documentary stamp tax of 0.7% of 1% of the value of real estate needs to be paid if real estate is transferred to a Partnership. Many tax attorneys now believe that these regulations are not valid and are applying for refunds for previously paid taxes. There may also be ways to make the transfer in a manner that would reduce the chances of an audit by the Department of Revenue. Is a Family Limited Partnership right for me? A Family Limited Partnership is an excellent way to remove a significant amount of assets from your estate while retaining control of those assets. Family Limited Partnerships can be flexible and provide a means to keep assets in the family. How can a Family Limited Partnership help your family? Assume that a father sets up a Family Limited Partnership. He is a General Partner owning 1% and a Limited Partner owning 90%, and both of his children own 4.5%. The following protections can apply: 1. If the father is sued, creditors cannot seize Partnership assets (assuming that the Partnership was set up before any creditor problems began). 2. If a child gets divorced or is subject to creditor claims, the divorced spouse or creditor(s) cannot obtain Partnership assets.