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.
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