whats-all-the-fuss-about-family-limited-partnerships-flps
What’s All The Fuss About Family Limited Partnerships (FLPs)?
Writen by Carlos Lee
In the last few years, many tax advisors and attorneys across the country have been touting the tax benefits and asset protection advantages of Family Limited Partnerships (FLPs). Many people rushed into forming FLPs without knowing exactly what it can or cannot do. To make sure you are knowledgeable on the subject, here are the main problems associated with FLPs.
A recent federal appeals court decision could spell big trouble for advisers telling clients to set up family limited partnerships (FLPs) as a means to reduce estate and gift taxes.
In Albert Strangi et al. v. Commissioner; No. 03- 60992 (15 July 2005), the Fifth Circuit Court of Appeal affirmed the decision of the Tax Court to value the FLP assets at fair market value and the proposed estate FLP discounts were denied. As a result, the IRS charged tax deficiency of $2,545,826 plus interest was sustained!
The court found that Strangi had continued to be in possession of or benefited from the transferred property and there was no business purpose to the transfer of the assets to the FLP. Under IRS Code, the transfer was invalid and the assets should have been included in the taxable estate, the court concluded.
The lesson one can learn here is that for the tax advantage to hold up in court, a person must have a business purpose to transfer assets into a FLP and not just for tax reduction. In addition, the original asset owner cannot enjoy the assets of the FLP as if he/she still owns them personally.
ASSET PROTECTION THAT CAN BACKFIRE
A FLP provides no asset protection. If one of the assets in the FLP incurs a liability such as when a tree branch on a property falls on a person, the FLP becomes liable for the accident and the victim can sue the FLP and all the assets in the FLP can be up for grab.
If someone sues you personally and wins and you are a partner of the FLP, the judgment creditor can obtain a charging order against your partnership interest and receive all the rights of your partnership interest including all future distributions from the FLP until the judgment is paid in full including interest.
You haven’t heard the worst yet!
Most states allow a judgment creditor to go further and foreclose on your FLP interest. Foreclosure essentially means that the creditor can seize your partnership interest and become the general partner of the FLP. When that happens, the judgment creditor can control and keep all the distributions from the FLP and charge a management fee as a general partner even if the total amount he receives from the FLP exceeds the judgment amount! In other words, if you have a FLP and the total value of the assets in the FLP is $2 million and your creditor has a judgment on you for $250,000, he can move to foreclose on your FLP interest and become the general partner of the FLP. He will in effect have complete control and receive all the benefits from all the assets in the FLP. Therefore, instead of giving up just $250,000 on the judgment, you could lose the entire $2 million in the FLP to your creditor.
The lesson here is that FLP is a poor vehicle for asset protection.
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Carlos Lee, MBA, is the senior consultant for Asset Protection Consulting Group. Visit Asset Protection Consulting Group to learn more about how to bulletproof your assets against future lawsuits. |
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