Using a Family Partnership to Lower Taxes on Your Investments
One of the most versatile and powerful tools in
the ongoing struggle to save taxes and protect your
wealth from frivolous or vengeful lawsuits -- not to
mention absurd liability claims -- is the family
limited partnership (FLP). One common use of FLPs is
to reduce your income tax liability. As an estate
planning vehicle, FLPs can also help you avoid
inheritance taxes.
As an asset protection vehicle, FLPs combine the
best of both worlds; they allow you to keep 100%
control of your assets while at the same time placing
them beyond the reach of creditors. Although usually
used by Americans, for foreign investors with U.S.
assets or business, a U.S. limited partnership might be
the first line of defense against exposure to the
lawsuit-happy legal environment in the U.S. Even if a
creditor wins a judgment against you, he may not be
able to collect a dime from your partnership interest -
- a fact that is inclined to make even the most
pugnacious adversaries eager to settle.
We'll outline how to use a FLP to achieve each of
these advantages in due course. But first, let's
establish exactly what we mean by a family limited
partnership. A partnership is merely an association of
two or more persons (or other legal entities, such as
corporations or trusts) in some kind of joint venture.
According to Section 761 of the U.S. Internal
Revenue Code, a partnership is "a syndicate, group,
pool, joint venture, business, or other unincorporated
organization through or by means of which any business,
financial operation, or venture is carried on..." In a
limited partnership, there are two kinds of
participants -- general partners and limited partners.
The general partners have management and control
of the partnership's assets and activities. And they
are liable for any debts or claims against the
partnership. Limited partners generally have no say in
the running of the partnership's affairs, and they have
absolutely no personal liability.
A typical FLP might have a husband and wife with a
general partnership interest of perhaps 10% and
children (and perhaps relatives) with limited
partnership interests totaling 90%. Such an FLP might
contain the family business, or other assets. Note
that in this example, the husband and wife, as general
partners, maintain 100% control of the FLP, despite
owning only 10% of it.
Income and estate tax benefits
For tax purposes, income earned by a FLP is
reportable on the individual income tax returns of the
partners. (Usually income is allocated among partners
according to the fraction of their partnership
interest.) This means that you can use the FLP to
spread the tax liability for family business among
family members -- such as minor children -- who will be
in a lower tax bracket.
FLPs can also be used as a simple means of giving
the family assets to children in small amounts in order
to avoid inheritance taxes. In this case, the FLP
would initially be set up with the husband and wife
having both a general partnership interest of 10% and a
limited partnership interest of 90%.
Each year these parents could give a fraction of
their limited partnership interest to their children
(and heirs). Each parent can give $10,000 of their
limited partnership interest to each child every year
without incurring any U.S. gift tax liability.
In this way, the parents' taxable estate can be
substantially reduced over a period of years. What's
more, even though they may have given away 90% interest
to their children, as general partners, they enjoy
complete control of all FLP assets.
Asset protection
Suppose you are sued, and a creditor wins a
judgment against you. Suppose further that you have
your home and other major assets in a FLP. In general,
a limited partnership may not be dissolved simply
because one partner is sued. In most jurisdictions, a
creditor cannot touch any of the partnership assets.
At best, he can hope to obtain something known as a
"charging order" against your partnership interest.
This will entitle him only to any distributions you
would receive as a general or a limited partner.
However, you remain the general partner despite
the judgment. This means that when and if any
distributions are ever paid out to partners remains
entirely under your control. As you can imagine, a
creditor armed with a charging order, waiting for you
to declare a distribution, may have to wait a very long
time indeed.
Furthermore, the fact that you have a creditor
looking over your shoulder doesn't mean you can't
continue to enjoy the benefits of the FLP. For
example, general partners often receive a salary for
their services to the partnership. You can also
receive advances or loans from the FLP.
You just can't receive any benefit that might be
classified as a distribution. For this reason, having
your assets in an FLP may make you a much less likely
target for a lawsuit in the first place.
One word of caution: What we have discussed so
far is the asset protection afforded by a FLP to
someone who is sued as an individual. If he has his
assets in an FLP, he will enjoy the benefits we have
described. However, it is important to keep in mind
that you as an individual are not the only potential
victim of a lawsuit. Your FLP itself could also be
sued.
For example, suppose the family business is
organized as a limited partnership and the business is
sued for malpractice or breach of contract. If the FLP
itself loses in court, then the charging order concept
does not apply -- and all of its assets are available
to creditors for attachment.
For this reason, it is often wise to divide assets
with liability exposure among several partnerships or
corporations. For example, many taxi companies
establish a separate corporation for every single
vehicle. That way, a judgment against one part of the
business need not necessarily imperil all the others.
Accordingly, the most effective asset protection
scheme will almost always make use of several of the
structures available -- such as corporations, foreign
corporations, and foreign trusts. It is indeed
possible to make your financial defenses truly
impregnable.
Remember, too, as you read the following sections,
that your investments can be further protected by
various combinations of family limited partnerships and
trusts, depending upon your individual needs. Not
every investment needs to be placed in your personal
name -- and since the FLP is tax neutral, or even
offers tax savings, it may be an ideal vehicle for
making some of these investments.
Asset protection and tax savings
While it is very nice to save on estate taxes,
most would be much more interested in saving taxes this
year, right now while you are still alive. The "estate
plan", when properly implemented has the delightful
side effect of making excellent use of your children
before they thought they could, or were inclined to be,
helpful. Remember that children over the age of 14
have their very own tax brackets which start at 0% and
linger at 15% for a time or so, just as yours did, and
only after more income than they will make or than you
need to give them for their support jump up to the
higher tax brackets. It is possible, especially for
the self-employed,to cut the total tax bite in half by
simply spreading the tax liability among family
members.
At this point you say, "Now just a minute, I know
what you are about to say, and I assure you that giving
assets or income to my children at this stage of their
teenage lives is a type of suicide that I do not
contemplate." You are right! Let me assure you that
no one is foolish enough to suggest that any assets or
income should be put under the "control" of children,
who at the age of 16 think that a 944 Porsche turbo
something or other is an appropriate investment.
The Family Limited Partnerships, and Children's
Trusts allow income to be attributed to the children's
tax brackets while leaving the "control" and "use" to
more responsible parties. In the case of the Family
Limited Partnership, the more responsible party would
be you. In the case of the Children's Trust, that
person would be a trusted other. However, the children
and their guardians, and once again, you, would be able
to have lower tax bracketed dollars available for
luxuries such as family trips, piano lessons, math
camp, private schools, college, medical school, etc.
Consider this: Mr. and Mrs. Business Partners set
up a Children's Trust for their children and funded it
with real estate in which their business was housed.
The kids wanted the building to be a retail space
suitable for an ice cream parlor, but since they were
not in charge of the decisions, the building purchased
was an 80,000 square foot steel and block industrial
building suitable for the parent's manufacturing
business.
The business, which had a good profit picture and
cash flow, paid rent to the Children's Trust, thereby
writing off the lease payments at a higher tax bracket
than the children's tax bracket and accepting the
payments in the lower children's bracket. Tax savings
were realized each year. In addition, Mr. and Mrs.
Business Partners suggest to the Children's Trust,
that, with the profits from the lease, it could buy
office equipment which it could lease to the business
on a "one year renewable lease" for market lease
payments, i.e., 75% of the value of the equipment each
year. More tax savings were realized.
It is only incidental to this discussion on the
advantages of the "estate plan" to mention that when
Mr. and Mrs. Business Partners went out of business
because the widgets which the parents were
manufacturing were replaced by a new super duper better
thing, the Children's Trust survived the parent's
bankruptcy and with the appreciated value of the real
estate and value of the still owned equipment, sold its
assets and loaned Mr. and Mrs. Business Partners
$500,000.00 to start a new business.
The above examples are illustrative of the old
adage, "divide and conquer." If they only file a joint
return, no married couple will ever get ahead tax wise.
If through a proper estate plan additional entities are
created the serve the dual purpose of providing lawsuit
and asset protection while dividing income into lower
tax brackets. Creating additional entities does itself
provide a record keeping and filing burden. It is bad
enough facing April 15th each year with one
incomprehensible form! However, if you are unwilling
to pay attention to the details there are others who
will do it for a fee. Failure to care may result in
exposure to judgments and the possible greater burden
of "starting over."
One major caution must be mentioned, as some of
these asset protection techniques are taking on aspects
of a fad. The courts can set aside a transaction on
the basis that it is a sham, despite what your fancy
paperwork says. A family limited partnership formed on
the eve of a judgment, with no business purpose and no
purpose other than evading the creditor, is likely to
be set aside by the court. The same is true of trust
arrangements made in the same way.
These problems can be avoided by making such
arrangements in advance, having sound and proper
purposes other than avoiding ones just debts, and to
some extent using foreign jurisdictions to make seizure
more difficult.
It is important to stress that there are no "magic
bullets" in asset protection, and there is no instant
solution. Setting up an asset protection plan --
whether it be partnerships, offshore trusts, domestic
trusts, or some combination, requires expert advice.
Preparing your asset protection plan
One of the best ways to protect yourself is to
have professionals prepare an asset protection plan in
advance of any problems. In the process of doing so,
many people are discovering that they can eliminate
most income taxes through the proper use of family
limited partnerships, offshore trusts, corporations,
and annuities.
Creating an asset protection plan is not
expensive, and provides a great deal of assurance that
you and your family will have the benefit of the money
you have built up through years of work. Asset
protection plans are a relatively new area of law,
prepared by lawyers who specialize in protecting what
you own instead of in suing people.
Asset protection is different from traditional
retirement or estate planning. It is the systematic
and integrated protection of your family and business
from risk.
Most financial planning is intended to help you
establish wealth so you can retire, and pass on as much
of that wealth as possible to your family after death.
Asset protection plans include estate plans but
are intended to also help you keep your wealth while
you are living. They often involve legal structures
such as family limited partnerships, children's trusts,
exempt assets, offshore trust arrangements and living
trusts.
Asset protection plans are fully legal. It is not
something for people who might want to avoid the law or
their responsibilities. The law is clear as to what is
permissible and what is not. Asset protection simply
gives protection against unfair lawsuits and gives a
level playing field to operate from.
The goal is to structure the plan so you never
have to misrepresent yourself or worry about the
legality of the plan.
The best way to do this is to seek the assistance
of professionals, and there is now a firm that works
with clients from all over the country. They can also
work with your existing lawyers or accountants if you
wish. For an information package please write: Asset
Protection Corporation, Suite 201A, 14418 Old Mill
Road, Upper Marlboro, Maryland 20772.
The family limited partnership approach can be
used in conjunction with the corporation strategy
mentioned in the previous chapter, by having the family
limited partnership own the corporation.
