Family Limited Partnerships & Protecting Your Assets
Family Limited Partnerships
The Family Limited Partnership (FLP) has been a popular business entity for wealth management, tax minimization and wealth transfer maximization. Under the right circumstances, FLPs traditionally helped taxpayers remain in control of their wealth even after transferring it to their loved ones. Additionally, many of these transfers were made at a significant discount, thereby further leveraging wealth transfer tax savings. Not surprisingly, while FLPs have been employed as a planning panacea by taxpayers, FLPs have received additional scrutiny from the IRS and some courts in recent years.
Simply put, a Family Limited Partnership is a Limited Partnership among family members. The FLP is often created by the wealth-owning generation, typically the parents. The FLP creators are initially both the General Partners (GPs) and the Limited Partners (LPs) at the time they contribute assets to the FLP. The lion’s share of the contributed assets is thereafter assigned to the LPs shares. Even so, the GPs hold all of the management control over the Family Limited Partnership assets.
IRS & Judicial Scrutiny
Given the powerful tax and wealth transfer benefits available through FLPs, it is easy to see why the IRS and some courts do not like them. First and foremost, an FLP must be created for a business purpose ... not just for estate planning. For example, a valid business purpose may be to maintain family ownership and control of assets while they are transferred between generations free from the claims of third-party creditors and probate. Any planning with an FLP must begin with a solid business purpose in substance, as well as in form.
FLPs are not for everyone. Between legal fees, valuation fees, required state filings and reports, and tax returns (for the FLP, the GPs and the LPs), FLPs may require a substantial commitment in time and resources.
Statistically and anecdotally, we all know that the number of divorces, lawsuits and bankruptcies is staggering. While no one believes lightning will strike them, wealth created through a lifetime of work, saving and investing can be lost overnight if these forms of man-made lightning do strike. To protect your assets from such disaster, proper risk management strategies should be given careful consideration. These strategies include exempting your assets from the claims of creditors and limiting your liability through legal entities and transferring your risk through insurance.
State and federal laws may exempt some of your assets from the claims of creditors. Depending on your state of domicile (i.e., your legal residence), the equity in your primary personal residence may be protected from creditors. Protection also may extend to your retirement funds and even the cash value of your life insurance.
Many entrepreneurs operate their businesses as sole proprietors rather than through a legal entity, such as through a Corporation or a Limited Liability Company. Whether their business is home-based or in the Fortune 500, these business owners are attracted by the informality of sole proprietorship. They also do not want to incur legal fees to create and maintain a legal entity. However, in addition to other advantages, conducting business through a legal entity may offer substantial risk management benefits.
When was the last time you reviewed the details of your liability insurance program with your insurance professionals? Are your policies current? Are the coverage limits adequate and are the deductibles reasonable? Have you scrutinized the policies for loopholes? Remember: the fundamental philosophy of any insurance coverage is to pay a premium you can afford, to transfer a risk you cannot afford. Take time to understand both the risks you have retained and the risks you have transferred.
Managing your risk, like avoiding lightning, requires that you make proper plans in advance of the storm. Take time today to protect your wealth tomorrow.
This publication does not constitute legal, accounting or other professional advice. Although it is intended to be accurate, neither the publisher nor any other party assumes liability for loss or damage due to reliance on this material.
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