I have written before about a few ways someone in the Bay Area can protect his or her assets from creditors. I want to expand here a bit on the idea of a family limited partnership (FLP), and how this might be a beneficial estate management arrangement for you.
How a FLP Works
A family limited partnership functions much like a holding company, with general and limited partners who have an interest in the partnership. This allows family members to pool resources and assets into a single entity that is easier and less costly to manage.
For the sake of illustration, let's create a very simple two-person partnership: A mother, the general partner; and her daughter, the limited partner.
Suppose in this example that mother and daughter have an equal 50-50 interest in the partnership (usually that would not be the case – in most cases mother would be the “general partner” with a 1% interest and daughter would be the “limited partner” with a 99% interest). Because daugther is only a limited parter, she lacks any control over the assets or their marketability - only the general partner may acquire or sell assets in the partnership.
This offers two very useful forms of protection.
Protection From Creditors
Suppose in our case that the daughter, the limited partner, has outstanding debts. Her creditors could theoretically obtain a “charging order” (a court order to pay over any distributions) for part of her interest in the partnership. However, the creditors could only receive distributions from this interest when the general partner distributed anything. The daughter has no control over distribution.
Therefore, should her mother, the general partner, simply never distribute anything, her daughter's creditors could simply be left with a taxable income yet no cash distributions.
Protection From Some Taxes
Now, suppose the mother would like to contribute $200,000 cash to the partnership. After she has made the contribution, she gifts half of the contribution to her daughter’s share. If mother had given her daughter $100,000 directly, the fair market value of the gift would be $100,000 and it would be fully subject to gift taxes.
But mother didn’t give her daughter $100,000 – instead, she gave daughter a gift through the limited partnership, and there are restrictions on daughter’s ability to use that $100,000. Because of those restrictions that $100,000 gift is worth something less than it would have been if the mother had simply handed her daughter $100,000 in cash. As a general rule, the more restrictions there are on a gift, the less it is worth.
The fact that the limited partner has no control over the assets means her claim to that $100,000 might not be so valuable to anyone else. Once that lack of control is factored in to the valuation, fair market value for that gift in the partnership might only be $95,000. Therefore, the gift tax would be based on the $95,000 value.
While this exchange is perfectly legal, it needs to be noted that only a qualified appraiser can evaluate the fair market value of the limited partner's interest. It is also useful to note that gifts of cash within a limited partnership are usually appraised at “almost” the same value as the cash itself but that gifts of other types of property (such as land) are sometimes discounted by 15% to 40%.
If you require such arrangements to protect the your assets, you require experienced legal counsel to help you do it correctly. Put our expertise to work for you, and protect the assets that you have worked so hard to build! Contact us at (650) 325-8276 to explore your situation and execute the strategy you need.