The Family Limited Partnership (FLP) has become known in recent years as one of the most effective tools for asset protection. According to a Forbes article titled “Cut Your Taxes in Half,” not a few individuals have used this technique to cut down on estate tax by as much as 90 percent. Family Limited Partnerships, with other strategies, offer excellent advantages and opportunities for estate planning. Read on to learn more.

A brief background

Family Limited Partnerships are a type of limited partnership. Limited partnerships are an organizational structure consisting of at least one general partner and one limited partner. The general partner manages all business affairs, making him or her personally liable for all the company’s debts and obligations. The limited partner cannot directly participate in management, but have no personal liabilities in the company. They can, however, influence corporate decisions indirectly by voting on certain matters, much like a stockholder. One person or corporation can play both general and limited partner, as long as there are two or more persons involved in the partnership (married couples are considered one person).

Tax advantages

Partnerships are considered a “pass through” entity, which means the income is directly passed on from the company to the individual. Because it technically doesn’t have income of its own, it is completely exempt from income tax. The owners file an informational tax return every year stating their income and expenses, but do not pay taxes on the net income. The taxes are assumed by the individual partners, who can then structure their finances in a way that is most profitable to them. This is why many people use limited partnerships to avail of tax deductions for real estate and tax shelter investments.

“Nominee” Corporations

As the one with more corporate control, the general partner has the right to decide whether or not to distribute income to a given limited partner. To protect their interests, many Family Limited Partnerships opt to form a new company known as a Nevada Nominee Corporation, which will then assume the role of general partner. This offers the following advantages:

Protection from lawsuits: It is hard for creditors to claim stocks from a general partner corporation, unless the client himself owns it. The corporation will have to distribute the stocks to the limited partnership interests, which will require a separate, but inherently weak lawsuit from the creditor.

Privacy of ownership: Without a lawsuit against the general partner corporation, creditors have no claims on company information. It is not a set rule, but it does provide a good amount of privacy, and more importantly, it makes it difficult to prove the nature of the arrangement. The reason the corporation has to be formed in Nevada is that Nevada law is notably pro-business, allowing the use of nominee officers as official representatives of the company.

Transferability of ownership: Since a corporation’s shares can be sold, a general partnership corporation can easily be transferred from one owner to another.

No fraudulent transfers: In most cases, the general partnership corporation owns only a 1% interest in the Family Limited Partnership, which can be transferred for value. For-value transactions are hard to prove as fraudulent, providing further protection against lawsuits.

Management income: As a general partner, the corporation can charge management fees and distribute funds in any way – use it to pay employees, buy insurance, provide benefits, or purchase retirement plans.

Other benefits of the Family Limited Partnership

Benefits for limited partners: Limited partners put their money or assets into the partnership, in exchange for limited partnership interests. This makes them passive investors – they have no management control, but they have the same power to earn as general partners. This setup works for a Family Limited Partnership because kids can be made limited partners, gaining control over the assets only with their parents’ consent. In this sense, the Family Limited Partnership works much like a living trust.

Protection of family wealth: In a typical Family Limited Partnership, the Nevada Nominee Corporation – controlled by the parents – holds a 1% interest in the company. The remaining 99% are all limited partnership interests under the living trust, held directly or indirectly by members of the family.

How does this protect family wealth? The answer lies in a law called the Uniform Limited Partnership Act. The Act prohibits a partner’s creditor from taking assets held by the partnership.  Partners can then choose to transfer assets to the Family Limited Partnership, so that it’s impossible for creditors to claim them.

For example, if the husband is sued for $1 million in a case separate from the business, all his creditor can claim is an interest in the partnership. To get anything of value, he has to apply for a “charging order” – a directive for the general partner to pay distributions obtained from the partnership. That means the creditor can only take payments from the husband, but not become a partner of the company.

But a creditor will most likely refuse the charging order or the limited partnership interest, even when you offer it to them. This is because under the Act, he cannot obtain any assets, but still has to pay taxes on the interest.

The Uniform Limited Partnership Act Explained

The Act dates back over a century, when its provisions were adopted from the English Partnership Act of 1890. The law as it is today is based on the Uniform Partnership Act, into which the law was adopted since the 1940s. The provisions are designed after a public policy stating that a partnership’s business activities should not be affected by non-business issues, particularly the personal debts of the partners. The point is simple – one partner should not have to suffer for the debt of another.

Cutting down on estate and income tax

The Family Limited Partnership can be used to reduce estate and income taxes for individual partners. Here’s how:

Income tax benefits: Income from Family Limited Partnerships can be spread between the partners, setting off the high bracket taxes typically paid by parents and the lower ones paid by children aged 14 and up.

Estate tax benefits: By granting limited partnership interests to children or grandchildren, it is possible to lift the value of assets from one’s estate while keeping control of the asset. This helps to protect family and personal wealth, in much the same way as the Uniform Limited Partnership Act.
This usually requires an estate plan structured to include a Family Limited Partnership holding all the family assets. With the parents as general partners, the children can be given limited partnership interests with a value equal to the maximum estate tax credit. In the following years, they could then get interests equal to the annual gift tax exclusion.

But IRS rulings state that limited partnership interests must be discounted to account for their lack of control and marketability. That means if a parent transfers $1 million worth of assets to a Family Limited Partnership, it does not follow that a 1% interest will be worth $10,000. This is because the interest cannot be sold, nor does it give the holder reasonable control of the partnership. Discounts on interests are usually upwards of 40%.

After the discount is applied, limited partnership interests can be given without exceeding tax credits. This way, it takes only two years or less to transfer the entire asset into the Family Limited Partnership, as opposed to the five or six years it would take with a less aggressive discount. It also eliminates future appreciation from the partners’ estate, especially for assets expected to increase in value.

Creating a Family Limited Partnership

The first step in forming a Family Limited Partnership is the filing of a Certificate of Limited Partnership with the Secretary of State. The owners will fill out a form with the names and addresses of all general partners, but not the limited partners. Note that the information will be available to the public, unless a Nevada Nominee Corporation is formed to take advantage of Nevada’s privacy laws.
Along with the Certificate of Limited Partnership, the partners will also submit a written partnership agreement. The agreement states, among other things, the purpose of the partnership, the profit and capital shares, roles of the general partners, and the degree of influence held by the limited partners.
If the Family Limited Partnership is created for asset protection and estate planning, the agreement must also outline the key provisions leading towards the objective. These provisions should be designed so that creditors cannot influence the affairs of the partnership, and that the general partners (usually the husband and wife) always have complete control of the assets.

The next step is to plan out the funding of the partnership by deciding which assets can be transferred and how it can be done. To do this, it is important to distinguish between safe and dangerous assets. Dangerous assets are those that carry a high risk of lawsuits, while safe assets do not. Stocks and bonds are generally considered safe assets, while business assets such as corporations and LLCs are dangerous. The difference is significant because you don’t want dangerous assets as part of your Family Limited Partnership.

Dangerous assets: Dangerous assets should also be separated from each other and from safe assets, especially if they include real estate holdings. The best way to do so is to treat them as separate entities, usually by holding them in a real estate privacy trust or a limited liability company (LLC). This is because the liabilities associated with them can be isolated in the trust or LLC, rather than help by any one of the members.

Safe assets: In most cases, safe assets can be contained together in a single Family Limited Partnership. Family homes are considered safe assets because liabilities are usually covered by insurance, but there are also tax issues involved when transferring them to the Family Limited Partnership. According to Section 163 of the Internal Revenue Code, one can get deductions for “qualified residence interest,” or the taxpayer’s primary residence. This means that the mortgage interest deductions will not be affected in any way by transferring to the Family Limited Partnership.
Other assets you can transfer to a Family Limited Partnership include:

Bank and brokerage accounts: These are considered safe assets because they have no potential liability. Bank and brokerage accounts can be created in the name of the Family Limited Partnership by simply presenting a copy of the Certificate of Limited Partnership and the company’s taxpayer identification number.

Other interests: Family Limited Partnerships are great for holding interests in other entities, such as businesses, real estate LLCs, and real estate privacy trusts. However, note that the Family Limited Partnership can only hold interest in the entity, but take part in the business. Otherwise, the Family Limited Partnership can face a lawsuit and lose all its assets.

Family Living Trust ownership: Usually, the role of the Family Living Trust is to hold 99% of the ownership of the Family Limited Partnership, with the general partner holding the remaining 1%. It can also hold interest in other safe assets, which provides excellent opportunities for tax savings, estate planning, and asset protection.
Other advantages of Family Limited Partnerships

Centralized control: In a Family Limited Partnership, all family assets are controlled from a single entity. This makes transferring to children much easier, because it only involves changing directors rather than the whole re-titling process.

Privacy: As a limited partnership, the Family Limited Partnership is not required to disclose who controls the general partner corporation. To transfer control, the old manager only has to resign and make way for the new one.

Use as a prenuptial agreement: Because the two parties’ rights can be outlined in the partnership agreement, each spouse can manage their own single-member LLCs as part of the Family Limited Partnership while retaining joint ownership.

Easy liquidation: When the partners wish to terminate the Family Limited Partnership, the process is much simpler than that of trusts, corporations, or other organizational structures.

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