Family Limited Partnership and Asset Protection

A Family Limited Partnership or FLP is a legal tool designed to centralize a family business or family assets into a single holding entity for asset protection and tax savings. FLPs unique tax ability can be used to minimize estate taxes by transferring FLP shares between generations, at lower tax rates than would be applied to regular partnership’s holdings. In some respects, FLP’s asset protection capabilities are better than a corporation. They are based on the concept of a “charging order.” A charging order protects assets of the FLP against creditors of the individual partners. For “family” planning, the Uniform Family Limited Partnership Act (2001) has many advantages. So if you need to protect the family business or the family farm or other family assets from creditors, consider using one.

A partner’s creditor can come in many forms. It may be the family who wins a lawsuit against you because of a trampoline accident, or the man you owe money to, or perhaps a bank that is foreclosing on an underwater delinquent property. The object in this article is to show you how to use the Family Limited Partnership (FLP) to protect your family assets.

One of the advantages of using a Family Limited Partnership (FLP) over a corporation is the fact that when you or another partner gets in trouble through a lawsuit or bad financial situation, the assets in the FLP will be protected. Sure corporations are powerful legal tools and are often used in preference to an FLP, but they don’t protect the company’s assets against personal liability. This isn’t a big deal in a big corporation, because if the creditor of one shareholder gets the shareholder’s stock in the company, the new owner of the stock can’t affect the operation of the corporation in any real meaningful way. However, in your little company, if the creditor gets your stock, the creditor effectively owns the corporation and all of its assets.

Let’s say one of your children bought a piece of property and it is now underwater. They are losing their property. They will in all likelihood end up as a debtor with a large deficiency judgment against them. When a creditor gets the judgment, they will try to collect from all the assets your child has, including their interest in the FLP.

Many people hold their rental properties in an LLC. Let’s say your child’s underwater property is held in an LLC. That should mean that the deficiency can only be satisfied from the assets held in the LLC. That’s want you’ve been lead to believe. You are right, if the loan was given only to the entity, but most mortgages require personal signature from the owner of the entity. If your son signed personally, the creditor can look to the entity for satisfaction, and also all of his other assets as well. Those assets will include his stock or his interests in partnerships, Family Limited Partnerships, and other LLCs.

Whenever you are signing a loan, think who will be liable. If you sign as general partner of the FLP, you are personally liable. If you sign with your spouse, you are both liable. If you sign as corporate president, you are not personally liable. You need to limit the liability for the loan wherever possible. If at all possible, never have both spouses sign. If only one spouse has signed, then the assets of the other spouse should be outside the creditor’s grasp – at least in common law states. For asset protection it is always a good idea to separate ownership of assets between husband and wife. With the assets separated, all of the family assets are not at risk when there is a problem. However, this does not work in a community property state, because by law both spouses are considered to be one ownership unit.

In the above scenario, suppose the family assets are held in a Family Limited Partnership (FLP). When the child’s creditor tries to collect his debts, the best your son can “offer him” is his interest in the Family Limited Partnership (FLP). There are laws to protect limited partnership interests from the creditors of the individual limited partners. These are called “charging order laws.” The bottom line is assets held in an FLP are largely protected from creditors of the individual partners (family members).

Family Limited Partnership History

How does this happen? Historically, when a creditor took a partner’s interest, that put the other partners out of business. It wasn’t fair to the other partners and hogtied businesses. To maintain business functions, the courts recognized that the other partners in the partnership had to be protected. So charging order laws were developed which protect the other partners by only letting the creditor get the right to any economic benefit the debtor partner had in the partnership, but the creditor did not get any control. The creditor could not affect the management of the partnership or directly access any of the assets of the partnership.

The Uniform Limited Partnership Act, which governs FLPs in most states, was updated in 2001. The Act clearly makes the creditor’s only remedy a charging order. There isn’t any transfer of rights other than the economic interest, i.e., the expectation of a distribution of profits.

The bottom line is, even if you know the lawsuit is coming, you can start putting assets into Family Limited Partnerships to protect them. If this is done and the FLP documents are written properly, the assets can even be protected from the bankruptcy trustee. The most the bankruptcy trustee can do is get a charging order. The state’s fraudulent conveyance laws will control, but there is still a good chance you can comply with the fraudulent conveyance laws and get the property out of the creditor’s reach.

Family Limited Partnerships are one of the most powerful asset protection tools an attorney has. Their unique asset protection capabilities are based on the concept of a “charging order.” A charging order protects assets of the Family Limited Partnership against creditors of the partners and keeps the Family Limited Partnership intact.

By Lee R. Phillips

On December 5, 2013 / LLC / 1 Comment

1 Comment

Darry Perkinson
5:57 pm on November 25, 2020

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Family Limited Partnerships or Family Partnerships

“Family Limited Partnerships” or “Family Partnerships” are smart legal tools useful for family estate planning. Using them, a family can shift income from high tax bracket family members to lower tax bracket members and save taxes. Mom and dad can gradually transfer ownership of family assets to the children or grandchildren and still keep control the assets. Family limited partnerships or family partnerships also protect assets and are used for a number of various estate planning strategies.

Family Limited Partnerships or Family Partnerships Shift Income and Save Taxes

If you have a business, invest in real estate or make money in any way other than as a W2 employee, and you find yourself with a tax problem. That’s a great problem to have, but you need to figure out how to save taxes and do your estate planning. Using a family partnership, you can divide up your assets by “giving” them to family members. This will reduce the value of your estate for estate planning purposes and let you “shift” the income generated by the assets to the “owners” of the assets, only “passive income can be “shifted” to someone else.

You have to be careful using this strategy, because a gift tax kicks in when family members are actually being given an interest in the asset. Any time there is a gift, you need to think “gift taxes.” There are several ways to get around gift tax issues. I cover a number of them in my book Protecting Your Financial Future.

A limited partner is responsible on their tax returns to pay taxes on their share of the family partnership profits. If the limited partner is in a lower tax bracket, they don’t pay as much in income tax, and the family saves taxes. This is a great way to “help” family members who are in lower tax brackets while the family saves taxes as a whole.

If children under age 19 or 24 for college students become limited partners a special “Kiddie Tax” kicks in. The Kiddie Tax only allows about $2.000 in passive income to be taxed to your kids before they have to start paying income tax at daddy’s rate. After a minimum about of income is shifted to a child, a huge penalty tax kicks in. The IRS is determined to discourage income shifting. They keep making the Kiddie Tax rules more powerful. Note that if you are in the “sandwich generation” and find yourself supporting older family members, the Kiddie Tax doesn’t apply.

Limited partners can also take any losses allocated to them by the family limited partnerships or family partnerships. The losses will reduce their taxes. Even though limited partners can take losses on their tax returns, they are not responsible for any of the family limited partnerships or family partnerships liabilities. Creditors of the family limited partnership can only go after the value of the limited partner’s interest in the family partnership. However, the general partner of the family limited partnerships or family partnerships is fully liable.

Family Limited Partnerships or Family Partnerships Asset Protection Tips

While family limited partnerships or family partnerships have great liability protection for the limited partners, they are an asset protection problem for the general partner(s). The general partner, who makes all the decisions and holds all the power, is also personally liable for all the liabilities and debts of the partnership. So while limited partners are only liable for the amount of their limited partnership interests, general partners are liable for everything.

To solve this problem many attorneys set their clients up with a corporation or an LLC (limited liability company) as the general partner of the family partnership. This supposedly prevents mom and dad from being personally liable as general partners. The key words in the first sentence of this paragraph are “set their clients up.” The attorney has set up their client with two entities, the family limited partnership and an entity that acts as the general partner.

Why not just use a Limited Liability Company (LLC) in the first place and skip the family limited partnership? The attorney got two fees, one for the family partnership and one for the general partnership entity. Now you have two entities to file taxes for, pay fees ever year for, and “maintain.” There isn’t much you can do with a family partnership that you can’t do better with an LLC.

Both the LLC and the family limited partnership have a powerful asset protection tool called “charging order” protection. Charging orders are used to protect the assets of the family limited partnership from the personal creditors and liabilities of the partners (limited or general). Charging order protection is a big deal that most attorneys never talk about.

Family Limited Partnerships or Family Partnerships Save Taxes – Both Estate Taxes and Income Taxes

Traditionally FLPs were used for estate planning purposes to reduce the value of mom and dad’s estate. With the estate tax exemption raised to $5 million, estate planning designed to reduce estate taxes isn’t as big of an issue as it used to be.

If your estate is over $5 million it works this way. Say you have a large piece of property and another big asset, such as business stock, if you transfer them into the family partnership, you can still control them, as the general partner, but their value is out of your estate for estate planning purposes. Use the gift tax strategies so you don’t have a gift tax issue.

The family limited partnerships or family partnerships are neat, because you are giving away value, but you are retaining full control of the assets. By law, the general partner(s) of the family limited partnership control the assets of the family limited partnership. Limited partners have no say in the management of the family limited partnership assets. So you maintain control, yet you can still give away value in your estate to your children and grandchildren.

Family limited partnerships or family partnerships make good estate planning and asset protection entities. It is a good idea to study how to use them and seriously compare them to the LLC. Either one of the entities is a good estate planning tool. I go over estate planning and the tools a lawyer has available in my book, Protecting Your Financial Future. Your advisors should be able to give you good reasons why you should use a family limited partnership or an LLC. Make them justify what they are doing for you.

On September 29, 2011 / / Leave a comment