The Family Limited Partnership can provide a strong layer of defense between your assets and creditors. Once you’ve established an FLP, creditors going after the assets in the business are tough. In the event that a judgment is granted to a creditor, there is a specific court judgment that must be carried out in order to try to receive distributions of profits from the partnership. Even if the creditor receives a collection order, that does not guarantee that you will be paid any amount on the debt, but it does put you in a position to become a recipient of income, whether or not earnings are recognized. The money is not distributed to the creditor, but the creditor must pay taxes on the derived income.
The FLP is one of the most effective tools for asset protection. It helps reduce estate and income taxes, provides the ability to manage assets, while denying creditors access to assets.
General partners have the majority of control, while limited partners have little or no control. The law rejects the rights of creditors to obtain interests in the company. FLPs protect your assets from lawsuits and help you maintain control over your assets. FLPs are used to protect real estate, stocks and bonds, cash, jewelry, furniture and belongings, and any other personal and business assets. The FLP is a fiscally neutral entity. Unlike a corporation, you can freely transfer assets in and out of the Family Limited Partnership without worrying about an adverse tax effect.
Establishment of a FLP
The first step to take is to properly establish an FLP based on the needs of the client. The partnership agreement must be precisely drafted and ownership must be determined. Assets must be legally transferred to the FLP. Once this is done, your assets are protected. The FLP must be filed with the appropriate state official, usually the person who runs the corporations. Check with your state division of corporations to determine the requirements and fees required for proper filing.
How does it work
If a judgment is obtained, a creditor must acquire a charging order against the corporation from a court of competent jurisdiction. The collection order entitles the creditor to the debtor’s portion of the FLP distributions. However, if no distributions are made, the creditor does not receive any money. The general partners who are the managing partners of FLP maintain control of any distribution. If the partnership has profits that are not paid to the partners, the creditor receives a K-1 tax form along with all the partners. The amount shown on this tax form must be included on the creditor’s income tax return and pay any taxes to the IRS on money never received. As a consequence, few creditors request a collection order. The partnership agreement is confidential and is not filed with any government agency. 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 society is generally managed by a family corporation to ensure the viability of the society for subsequent generations. FLPs can provide solutions to many of the fundamental challenges families face, such as:
• Correct administration of family assets during the life of the elders of the family.
• Capitalize on full value as assets pass to heirs
• The reduction of current income taxes
• Reduction of the taxable value of the family patrimony
• Help gift assets to family members
• Safeguard family assets from unwarranted claims by creditors
Organization of a FLP
In an FLP, a family’s assets are contributed to the partnership in exchange for limited partnership units. The division of the units is generally between the family members who are the limited partners and one or more corporations, LLCs, or trusts that own the larger number of units as the general partners. General partners are the management portion and limited partners have no say in the operation of the business. The partnership will pay the general partners the 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 allowed under IRS regulations as with any business.
Income Tax Advantages of an FLP
Once properly prepared and with the consent of the general partner or as determined in the Partnership Agreement, any of the units held by any limited partner may be gifted to family members, purchased by trust in exchange for a promissory note, or donated to a charity in any form desired. If donated to charity, the grantor will receive an income tax deduction for the fair market value of the donation. Please note that not all options are necessary or advantageous to limited partners, therefore appropriate advice from experts in the field may be required.