FAMILY LIMITED PARTNERSHIPS*

Chris Riser and Jay Adkisson are the authors of the best selling "Asset Protection: Concepts and Strategies" (McGraw-Hill 2004). Chris Riser is currently the Chairman of the American Bar Association's Asset Protection Planning Committee. Their operating agreements and related documents for limited partnerships and limited liability companies are much sought after by many practitioners.

LITIGATION INVOLVING FAMILY LIMITED PARTNERSHIPS

The firm litigates cases involving FLPs and similar structures, including the creditor-side attack and debtor-side defense of FLPs, disputes between partners, and disputes involving marketability and similar discounts.

*Please note that no attorney of the firm has sought board certification by any state as a specialist in any area of practice, and no attorney of the firm claims to be a specialist in any practice area. The firm does not solicit new clients in any jurisdiction where the firm does not have a member of the firm licensed to engage in the practice of law.

Cautions About

Family Limited Partnerships

The basic operation of Family Limited Partnerships is discussed in “Asset Protection: Concepts and Theory” in Chapters 19 and 20.

Common Defects in Family Limited Partnership Structures

The term “Family Limited Partnership” (FLP) is a slang term used by planners. There is no statute anywhere that uses the term, nor does the Internal Revenue Code use it. What “Family Limited Partnership” refers to is a limited partnership formed to hold the family business or investments, with the idea that the parents will make gifts of their limited partnership interests to their children. Because the limited partnership interests are illiquid, so the theory goes, they should be subject to substantial discounts for federal gift and estate tax planning purposes.

Family Limited Partnerships also have some attraction as asset protection vehicles, primarily because the limited partnership interests may be subject to “charging order protection” in some states. See charging orders for more on this topic.

Because of the potential federal gift and estate tax benefits and potential asset protection benefits, FLPs are widely marketed by a variety of attorneys, CPAs, CFPs, and other planners. Unfortunately, FLPs are also marketed by numerous promoters who shamelessly sell one-size-fits-all cookie-cutter FLP structures and even sometimes also sell kits allowing clients to engage in do-it-yourself FLP planning.

When utilized correctly, FLPs can be very powerful estate planning and asset protection planning tools. The problem is: FLPs are almost never correctly utilized, and because of this they often fail to produce their promised benefits. The following is a list of common defects in FLP structures, not in any particular order and certainly not exhaustive:

Failure to Fund the FLP – Many people will go to great lengths to form their FLP and pay substantial fees to a planner to do so, but then never transfer any significant assets to it. Obviously, to the extent that assets are not contributed to the FLP those assets are not afforded either the tax benefits or asset protection benefits of the arrangement.

Failure to Maintain the FLP – Limited partnership require the payment of annual fees, and the failure to pay these fees can mean that the entity will eventually be stricken by whatever governmental entity formed it in the first place. If the entity is stricken, it ceases to exist as far as the state and IRS is concerned.

Failure to Follow Formalities – Although they do not have nearly the level of formalities as do corporations, limited partnerships are required to have Operating Agreements which must be followed, and the failure to have an Operating Agreement or to follow it can mean that the FLP could be disregarded by a court and treated as it never existed.

Non-Business Assets or Activities – Notwithstanding the use of the term “Family” in FLP, these are still limited partnerships, which are fundamentally business entities and are not meant for personal use. The family residence should not, for instance, be placed into a FLP, nor should normal family expenses (utilities, clothing, educational expenses, etc.) be paid from the FLP. The use of the FLP for personal purposes could result in the entity being disregarded for tax and asset protection purposes.

Parent as General Partner – From an asset protection viewpoint (and arguably an estate planning viewpoint as well) making the Parent the General Partner (GP) of the FLP is the single most common mistake in FLP structuring. The reason is that charging order protection relies on the GP to not make distributions to a limited partner’s interest for the benefit of a creditor. However, if the Parent gets sued, the creditor could probably persuade the court to enter an order compelling the Parent to make a distribution to the Parent’s LP interest, thus totally subverting the charging order protection.

Parent as both General Partner and only Limited Partner – If the Parent is both the General Partner and the only Limited Partner (LP), then a court may deem that since the Parent owns all the interests, there is no partnership and the Parent simply owns the FLPs assets outright (thus negating the charging order protection and any hoped-for tax benefits). As dumb as making the Parent both the GP and LP seems, there are actually promoters who sell cookie-cutter structures that make exactly this mistake.

Parent’s Living Trust as the GP – A variation of the foregoing has the Parent form a revocable grantor trust (a/k/a “Living Trust”) that acts as the General Partner. The problem here is that a savvy creditor of the Parent will go to the court and ask for an order compelling the Parent to revoke his or her Living Trust, thus making the Parent the direct GP of the FLP with all the problems that entails. The same problem exists for structures that make the GP a corporation or LLC which is wholly-owned by the Parent’s living trust, since revocation of the living trust will put the creditor in control of those entities, and thus in control of the FLP.