California Family Limited Partnerships

by: John B. Palley, Attorney

Family Limited Partnerships (often called “FLiP’s” or “FLP’s”) and Family Limited Liability Companies (FLLC’s) are a very common estate planning vehicle to add creditor protection and reduce estate taxation for people with assets. Being a California attorney this article is designed for clients who live in, have assets in, or have the desire to set up a family-business entity in California. For simplicity I will call these vehicles FLPs throughout. Historically the limited partnership was the more common business entity to use but now days LLC’s are often used. In any event the FLP is an estate planning vehicle that should be considered along with the more common revocable living trust, durable powers of attorney, living wills, pour-over wills, life insurance trusts and other similar documents. The FLP can create incredible asset protection and amazing tax savings for generations when set up properly. On the other hand, it’s important to note that an FLP is an advanced planning tool and, in my opinion, should not be undertaken by an attorney without significant experience with FLPs. There are estate and gift tax issues, huge property tax implications and just general distributions problems that can be created when a novice works on this advanced planning tool. It is most definitely not a document to be created using an on-line form as it is much more involved and customized when done properly. In addition to the above problems if an FLP is set up wrong you can easily set up a situation where you lose the asset protection and tax savings that you were trying to create.

Family Limited Partnerships (often called “FLiP’s” or “FLP’s”) and Family Limited Liability Companies (FLLC’s) are a very common estate planning vehicle to add creditor protection and reduce estate taxation for people with assets. Being a California attorney this article is designed for clients who live in, have assets in, or have the desire to set up a family-business entity in California. For simplicity I will call these vehicles FLPs throughout. Historically the limited partnership was the more common business entity to use but now days LLC’s are often used. In any event the FLP is an estate planning vehicle that should be considered along with the more common revocable living trust, durable powers of attorney, living wills, pour-over wills, life insurance trusts and other similar documents. The FLP can create incredible asset protection and amazing tax savings for generations when set up properly. On the other hand, it’s important to note that an FLP is an advanced planning tool and, in my opinion, should not be undertaken by an attorney without significant experience with FLPs. There are estate and gift tax issues, huge property tax implications and just general distributions problems that can be created when a novice works on this advanced planning tool. It is most definitely not a document to be created using an on-line form as it is much more involved and customized when done properly. In addition to the above problems if an FLP is set up wrong you can easily set up a situation where you lose the asset protection and tax savings that you were trying to create.

The Basics

An FLP is a business entity similar to any other limited partnership, LLC or even most corporations. That is, you file documents with the California Secretary of State to establish your new business entity name, reserve a tax ID number with the IRS and create governing documents for the new entity. These governing documents are where the differences start to come out. A true FLP is designed to create tax savings for future generations. To do that correctly one wants to create lack of marketability and minority ownership discounts. In addition one wants asset protection with their FLP. To carry out these intentions the documents used for an FLP are customized for the family closely held business. As will be discussed later you are looking to create true limited authority in the rest of the family so that you, typically the parent, retain control. Assets are then transferred into the FLP. Shares of the FLP (typically limited partnership interests or member interests) are then given or sold, at a reduced amount to family members. The FLP is then managed by the manager (typically the parents) until they no longer to wish to retain control. At that time control can be shifted over even if the parents retain some or all of their ownership interests. It’s important to point out this should be run like a true business. Separate business bank accounts should be maintained, corporate minutes taken, and all other business formalities should be followed.

Assets

What type of assets can be put into an FLP? Practically anything! Yes, it is a “business” and thus you can put the family plumbing business or winery or any other business into an FLP. However, more often FLP’s are used to hold rental properties are other similar investments. In fact, you can even put marketable securities such as stocks and bonds into an FLP. Truly, ANY asset can be put into an FLP. The valuation discounts will be different for different types of assets but truly anything can be placed into an FLP, even cash!

Asset Protection

FLPs provide great asset protection in two main ways: 1) by secluding and segregating your “business” assets from your personal assets and 2) by implementing the charging order protections which make it difficult for people to enforce personal judgments against the business assets. Some people create multiple FLPs to separate the assets even further and this is a good strategy. However, it’s important to make sure each is a legitimate and separate business and not just done for asset protection purposes.

Discounts

One the big benefits of FLPs is gifting discounts. That is, it is undeniable that being the owner of 10% of the stock of a company is not as valuable as owning 100% from a control aspect. That is, you have much less control… or, in fact, no control when you only own 10% of a company. With an FLP they are designed to give the other owners (often your children and grandchildren) less control so as to maximize this ownership or “lack of control discount.” Additionally, there is the simple fact that it can be very difficult to sell a small interest in a family owned business. Really what outsider would want to be a part of your family’s business? Thus there is the “fractional ownership discount” which further devalues the ownership as it can be very difficult to sell a minority interest in a family business.

Taxes

There are all types of tax issues to consider with an FLP; income, gift, estate, and property tax. This is the primary reason that FLPs should not be implemented by an attorney who is dabbling in estate planning and taxation law. There are major repercussions for doing things incorrectly and one false move can create a major tax problem. In addition to an experienced estate planning attorney you should have a seasoned tax professional on your team. A California licensed CPA is an important and crucial member of the estate planning team when using an FLP!

Conclusion

All told FLPs are NOT a simple device that should be implemented by everybody. There are annual state fees, tax issues, administrative costs, attorney fees and other similar costs that make them not right for everybody. However, for the right people they are a dynamic way to create asset protection and move assets around a family at a substantially reduced tax cost.

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