Defects in Family Limited Partnerships
The following are some of the common defects in Family Limited Partnership structures:
Failing to fund the Family Limited Partnership (FLP) – A good many individuals go to great lengths to form their Family Limited Partnership and are willing to pay a planner substantial fees to do so. However, they then fail to transfer any significant assets to it. Therefore, to the extent that these assets are not contributed to the Family Limited Partnership then neither are they given the tax or asset protection benefits of the arrangement.
Failing to maintain the Family Limited Partnership (FLP) – A limited partnership requires payment of annual fees. Failure to pay these fees can result in the entity eventually being stricken by the governmental entity that formed it in the first place. As far as the IRS and the state is concerned, If the entity is stricken, it ceases to exist.
Failing to follow formalities – Although they do not have the same level of formalities as corporations, limited partnerships are required to have Operating Agreements which are required to be followed. Failure to have an Operating Agreement or to follow could result in the FLP being disregarded by a court and treated as it never existed.
Non-business assets or activities – Despite using the term “Family” in Family Limited Partnership, these are nevertheless still limited partnerships which are fundamentally business entities and are not meant for personal use. Therefore, the family residence should not be placed into a Family Limited Partnership, nor should normal family expenses such as utilities, clothing, educational expenses, etc. be paid from the FLP. Using a Family Limited Partnership for personal reasons could result in the entity being disregarded for tax and asset protection purposes.
Having a parent as the General Partner – The most common mistake in structuring a Family Limited Partnership, (from an asset protection viewpoint) is making the parent the General Partner (GP) of the Family Limited Partnership. The reason for this is that charging order protection relies on the GP not making distributions to a limited partner’s interest for the benefit of a creditor. However, if the parent winds up getting sued, the creditor could persuade the court to enter an order which would compel the parent to make a distribution to the parent’s LP interest, thereby subverting the charging order protection.
Having a parent as both General Partner and only Limited Partner – If the parent is both General Partner and the only Limited Partner (LP), then a court may find that since the parent owns all the interests, there is in fact no partnership and the parent only owns the Family Limited Partnership’s assets which thereby negates the charging order protection and any tax benefits. Although making the Parent both the GP and LP seems rather silly, there are promoters selling cookie-cutter structures that actually make this mistake.
Having the parent’s Living Trust as the General Partner – Another variation of the foregoing has the parent forming a revocable grantor trust (also known as a Living Trust) acting as the General Partner. The problem is that a knowledgeable creditor goes to the court and asks for an order which compels the parent to revoke his Living Trust, thereby making him the direct General Partner of the FLP with all the problems that it involves. The same problem exists for structures making the GP a corporation or a Limited Liability Company (LLC) which is wholly-owned by the parent’s living trust, since revoking the living trust places the creditor in control of those entities, and ultimately in control of the Family Limited Partnership.
Having an individual as General Partner – Should an individual die, or is sued, management of the Family Limited Partnership may be thrown into disarray and there is potential for an heir or creditor to take control of the assets of the Family Limited Partnership. Therefore, it is a very bad practice in making an individual the General Partner of a FLP.
Family Limited Partnerships