|
THE FAMILY LIMITED PARTNERSHIP
A DYNAMIC ESTATE PLANNING TOOL
WHAT IS A LIMITED PARTNERSHIP?
Limited partnerships are nothing new. They have been around
for decades being used primarily to provide a vehicle to obtain funding for a myriad of
projects such as apartment complexes, shopping centers, office buildings and oil and gas
drilling projects.
Promoters typically wanted to have complete control over a project whereas investors
wanted a tax write off and limited liability should the venture go sour.
The limited partnership was uniquely designed to meet these requirements. A limited
partnership is operated by one or more general partners who exercise broad control over
its affairs. Thus, the promoter would be the general partner and could operate the venture
with little or no interference from investors.
All of the other partners in a limited partnership were called "limited
partners." Limited partners enjoyed two important attributes. First, unlike a general
partnership they had no personal liability if the venture went bad. Their only risk was
their investment in the limited partnership. Secondly, profits and losses passed through
the partnerships to the individual partners. These profits and losses could often be
manipulated to provide a much greater income tax "write off" to the limited
partners than the general.
In 1986 the income tax laws were drastically changed. One of the casualties of this tax
change was limited partnerships. Although limited partnerships are still used today they
are not nearly as popular as they were in years past.
HOW A FAMILY LIMITED PARTNERSHIP
DIFFERS FROM THE TRADITIONAL LIMITED PARTNERSHIP
Whereas the ability to give limited partners substantially all of
the tax write off of a venture was the driving force behind the proliferation of limited
partnerships in years past, this attribute of the limited partnership is not important in
the family context.
In the family situation the husband, wife or both are the general partners. They
control the partnership but a substantial portion of the ownership is given to the limited
partners who can be children, business associates or even a trust set up for specific
beneficiaries.
Typically a husband and wife would transfer their investment assets into a family
partnership. They would receive in exchange general and limited
partnership interests in the limited partnership in proportion to the assets they
transferred to it. Once the partnership has been established gifts of limited partnership
interests can be made to children or trusts.
THE MECHANICS OF SETTING UP THE FAMILY LIMITED
PARTNERSHIP
A limited partnership is created by written partnership agreement
which sets forth the terms of the partnership. A certificate of limited partnerships must
be filed with the Secretary of State along with the required filing fee. The limited
partnership must apply for a federal tax identification number and file an annual income
tax return.
Assets intended to be put in the limited partnership must be legally transferred to it.
A bank account or other depository account must be set up to provide a place to deposit
income and pay expenses.
INCOME TAX CONSEQUENCES
A limited partnership does not pay taxes. It must file an income
tax return, but all of the income or loss passes through to the partners in proportion to
their ownership interests. Each partner receives a K-1 showing their share of the
partnership income or loss which they attach to their individual tax return.
ESTATE TAX CONSEQUENCES
The family limited partnership provides an excellent opportunity
to avoid excessive federal estate taxation. By dividing the ownership of assets between
the entire family much of the appreciation that would otherwise accrue solely to the
parents instead accrue to the children thus avoiding estate taxation. Additionally, upon
the death of the husband and wife if no one limited partner inherits a majority interest
in the limited partnership a substantial control discount can often be claimed. Finally a
lack of marketability discount may often be applicable as well. These discounts can often
range from ten to fifty percent depending on the particular circumstances.
ASSET PROTECTION
One of the attractive aspects of the family limited partnership is the asset protection
that such a partnership can afford. Under the Uniform Limited Partnership Act if a
creditor obtains a judgment against the owner of a limited partnership interest all that
the creditor is entitled to do is surcharge the limited partner's interest. This means the
creditor is entitled to the distributions to that limited partnership interest. Since the
general partner controls distributions, it is difficult for a creditor to ever collect
anything even if the interest has been surcharged.
A further deterrent to the judgment creditor is the fact that the income from the
limited partnership interest is attributed to the judgment creditor once the limited
partnership interest is surcharged. The practical effect of this is that the judgment
creditor will incur income tax liability but may not get a corresponding distribution of
income from which to pay the tax.
For the asset protection aspects of a Limited Partnership to be fully effective, the
partnership must be in place and the assets in its possession prior to a partner incurring
the liability that gives rise to the charging order.
| 