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  • A family limited partnership is a regular limited partnership that happens to have family members involved. You create the partnership to accomplish certain business purposes, such as consolidation of family wealth or teaching younger generations how to manage wealth. In return for partnership interests, you transfer your assets into the partnership.

    A partnership must have at least two partners. In most family limited partnerships, there is a general partner and limited partners. The general partner manages and controls the partnership. The limited partners have no control. The partnership terms are memorialized in a written operating agreement.

    Typically, you control the general partner. On occasion, you will not wish to control the general partner, and we will discuss the reasons for that with you. Often, you will own limited partnership units, and you use these units to gradually gift limited partnership interests to younger generations. Control stays with you (because you control the general partner), while wealth moves out of your estate.

        Family Limited Partnership (FLP)
        Limited Liability Company (LLC)
        Family Limited Liability Company (FLLC)
        Professional Liability Company (PLC)
        IRA Trust
        Special Needs Trust
        Medicaid Asset Protection Trust
        Qualified Income Trust
        Irrevocable Life Insurance Trust


     


    Because of the way the partnership operating agreement is written, the limited partners have very little ability to transfer ownership. This is helpful in many ways. First, in case of divorce, the soon-to-be-ex may have claim to the value of the partnership units, but will have a hard time actually getting the units. Second, because the units are difficult to transfer outside of family, the units very often qualify for a discount for lack of marketability. Third, because they are limited partnership units, and the general partner is in control of the partnership, the limited partners have no control. The limited partnership units typically are appraised with a discount for lack of control.

    How does this work for your benefit? Let's assume that your partnership owns as an investment a share of IBM stock that is selling on the stock market for $100. Anyone could buy a similar share of IBM via the stock market. If you offered an investor the opportunity to buy the stock on the stock market, the investor would pay $100 for it. If you offered the same investor the opportunity to buy a unit of limited partnership interest equivalent in value to the share of IBM stock, the investor would not be willing to pay $100 for it. Why? Because the investor knows that the share of IBM stock comes wrapped in a package that includes dealing with someone else's family, as well as an onerous partnership agreement. The limited partnership unit has limited marketability, no control, and family drama. How much is the discount? That depends on an appraisal by an independent, qualified business valuation analyst. However, discounts of 10% to 40% or sometimes even higher are not unheard of.

    Why does this benefit you? Let's say that you have gifted to your son 20% of the limited partnership units in your family limited partnership. The assets of the family limited partnership include $1 million of IBM stock. Logically, your son's wife would think that your son is worth $200,000. However, if your son's wife were to initiate divorce proceedings against your son, the assets would have to be valued to be split up. Imagine her disappointment when the appraisal for the partnership showed that your son's limited partnership units were worth merely $140,000 due to a 30% discount for lack of control and lack of marketability.

    And it gets better! Let's assume instead that your son was at fault in a car accident. This is an outside liability, meaning it did not occur within the confines of an entity. The injured party sued your son, went to trial, and won a $1 million dollar judgment against your son. Perhaps your son is very handsome, absolutely charming, a great tennis player, but not much of a go-getter, and the only asset your son owns is the 20% of the limited partnership units in your family limited partnership that you gifted to him. The assets of the family limited partnership include $1 million of IBM stock.

    Logically, your son's creditor would think that your son is worth $200,000, and would want to take ownership of the limited partnership units away from your son in partial satisfaction of the judgment against your son. However, the injured party cannot take title of your son's limited partnership units. Instead, your son's creditor would have to go back to court to get something called a "charging order". A charging order is a piece of paper that says in essence, "Dear General Partner. Son owes me money. Instead of writing distribution checks to Son, please write them to me instead. Sincerely, Injured Party."

    You as General Partner are in charge of what? Determining distribution checks! So, while the charging order is valid, what do you do? Don't write distribution checks to your son!

    Does this mean that no money can come out of the partnership while any limited partner has a charging order against him/her? No. You as general partner may loan money, borrow money, pay wages, sell assets, buy assets-there are many ways to get money out of a partnership. You just don't want to make a distribution, because if you did, your son's pro-rata share would have to be paid to your son's creditor.

    As a partnership, under US Federal income tax law, your partnership files each year an informational income tax return known as Form 1065. The partnership pays no income tax itself, but is considered a "flow-through entity". The Form 1065 has attached to it Forms K-1. Each partner gets a K-1 that reflects his/her income tax from the activities of the partnership. Each partner includes the numbers from the K-1 on his/her personal income tax return, Form 1040.

    And here is the part where you may stand up and sing. While the judgment creditor holds a charging order against your son, your son's judgment creditor gets your son's K-1, and your son's judgment creditor has to include on his 1040 the income tax items as a result of the activities of the partnership. In other words, although the judgment creditor is not getting any cash flow because the general partner is not writing distribution checks, the judgment creditor will have to pay income tax on income attributable to your son from the family limited partnership.

    What does this mean in the big picture? If you have your family wealth tied up in a family limited partnership, it will be much easier to convince creditors or predators to settle immediately for whatever cash you offer them rather than fight in court. Personal injury attorneys are less apt to take on as a client someone who wants to sue you. If the personal injury attorney does take the client, he/she likely will counsel the injured party to settle, and quickly. The personal injury attorney knows that his client will be the most unhappy person in the world if the client goes all the way through trial, wins the trial, goes back to court, gets a charging order, and then, instead of getting cash, sits around waiting, and at the end of the year gets a K-1 that means he has to pay income tax to the IRS. The personal injury attorney's client now has lost money by winning-and the personal injury attorney, who most often gets a percentage of the winnings, has been paid nothing.

    This has been a gross simplification of an area of law that is onerously complicated. Partnerships are expensive to set up, expensive to maintain, and require constant care and feeding. If you do not have the time, energy, and money to do your partnership right, then choose a different law firm. Family limited partnerships are one of our most gratifying practice areas, but we have strict maintenance expectations. We, as your attorneys, your CPA, and you have to work together as a well-oiled machine to build and maintain your partnership to withstand assault. A poorly-maintained partnership is next to useless.


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    (407) 622-1900

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