One common and well placed tool for estate planning and Asset Protection is known as a “Limited Partnership” (LP), also commonly called an Asset Management Limited Partnership or Family Limited Partnership (FLP).
Below are some simple tips for managing your LP, safely, legally and effectively. Any LP created for you as an Asset Protection and Estate Planning vehicle is officially in the business of “managing your assets and investments” and must act like it to attain the full benefit and protection of the law.
The tool itself, like all of the best Asset Protection tools, is tax neutral. While this tool has legitimate tax and estate reduction benefits, we suggest that our clients tread lightly in those areas, and utilize the services of appropriate tax, accounting and legal experts when making decisions regarding these benefits.
1. Make sure that assets transferred into the LP are properly re-titled to reflect the LP’s ownership. Your interest in real estate (properly insulated in an LLC); personal property (transferred through a bill of sale) and marketable securities should be properly transferred to the LP and recorded as soon as possible so that the LP will be the proper titleholder when income is received from these assets. Records of all such transfers should be maintained with your LP records.
2. Risky assets should NEVER be put directly into your LP. They should be safety wrapped in LLCs or other vehicles so that real property liability is one arm’s length removed from the LP itself, this includes raw land. Safe assets, on the other hand, may be directly titled in the name of the LP. Examples of safe assets include stocks, bonds, securities CDs and money market accounts, to name a few.
3. Maintain comprehensive business records. All business receipts should be deposited into the LP account and all LP expenses should be paid from it. Make sure that all federal and state income tax returns are timely filed and accurately prepared. If possible, a monthly accounting of all partnership income and expenses should be maintained.
4. Separate tax returns are not always required for your LP. You may not need to file a separate tax return for your LP. For instance in Arizona, unless you have income that was generated within the state of Arizona they don’t want a separate tax return. Our client’s LP papers include a letter from the Arizona Department of Revenue to this effect, advise your accountant accordingly and always check with your attorney and/or CPA for specific tax advice – which I am NOT providing here.
5. Assets required for living expenses should remain outside the LP. Those assets necessary for your daily living expenses should be kept outside the LP so that it does not create the appearance that the LP is merely a personal account holding any given partner’s personal assets. If a major contributing partner finds it necessary to dip into the LP due to the nature and level of their contributions, it may lead to a direct piercing by either a judgment creditor of the LP, by a reverse piercing of the LP veil by a judgment creditor of that partner(s), or even by the IRS at the time of that partner’s death.
6. Refrain from co-mingling partnership and personal funds. Once the partnership has been fully formed, and an EIN (tax number) obtained, the LP should establish a separate Money Market account/ and or investment account.
7. Do not have the LP pay personal expenses directly. Instead, make a formal pro-rata distribution from the partnership to all partners if you need to withdraw cash from it. Then use the distribution to pay for the expense.
8. When possible, avoid “non-pro-rata” distributions to any one partner. Instead, make a proportionate distribution to all partners based on their percentage of ownership. These kind of distributions are better structured as a “loan” secured by a note with interest back to the partnership.
9. Consider having each partner make a capital contribution to the LP upon formation. This supports the idea and reality of the LP being a joint enterprise to which all partners have contributed.
10. Operate the LP in accordance with the terms of the partnership agreement. If this proves to impractical or if the LP’s needs change, amend the partnership agreement to accommodate the changes required in the LP’s operation in order to avoid an administrative dissolution of the LP.
11. Make sure that the LP should comply with all organization and filing requirements and other formalities requited by state law. This will help ensure that your LP maintains all required records and will help avoid any proposed administrative dissolution. Strict adherence to all sate law requirements is necessary to meet the stringent scrutiny of the IRS. In your case, you can be assured the LP was properly formed if created for you by us.
12. Do not transfer personal (non-business) assets into your LP. Your LP must have a valid business purpose, in the case of such partnerships we create the business purpose is the management of your assets and investments. The FATAL flaw of transferring non-income producing assets, such as your personal residence, furniture, and personal automobiles creates the appearance that the LP is being used for personal, as opposed to business purposes. More importantly, it carries the liability that each of those items may carry into the LP, defeating the essential purpose for which it was created.
13. Transfer business and income producing assets into the partnership. In addition to stocks and bonds your LP may hold your interest in income producing real-estate (if properly insulated in one or more LLC’s), personally owned office and business equipment, and any equipment necessary to operate a lab, records business or related enterprise. If any of these items are capable of generating liability they too should be isolated in an LLC, and that interest assigned to the LP, as you would with real-estate. Having your LP engage in multiple revenue generating and asset holding activities (i.e. real estate and equipment leasing, stock portfolio management) helps support the fact that this is a valid business that is a legitimate arms length joint enterprise.
14. Use the expertise of investment advisors to find safe growth vehicles for your investments. For instance, a combination of dividend paying stocks and interest bearing bonds could generate immediate, steady, and relatively determinable income that will both increase the value of your assets and prove the fact that the LP is indeed a for-profit business entity as opposed to a mere holding vehicle.
15. Do not transfer assets required to meet your fixed daily living expenses into the LP. Such items would include your personal revolving checking account; this is akin to co-mingling funds. If a court were to find that these assets were required or were used to meet your daily expenses it could include them in your estate thereby weakening the strength of your LP.
16. Make your LP act like a separate business entity. You can get cards and stationery in the name of the LP to help establish a business identity for the LP separate and apart from yourself. More importantly, the partnership should hold an annual meeting and should maintain the minutes of those meetings. In the case of LP’s created and maintained for you by us, we include that service. This is an important reason to schedule and follow-through with your “Annual Review” with a member of our firm. Upon the completion of your review the firm will re-assess the planning we have in place for you, recommend any changes or additions necessary, and generate meeting minutes that you may add to your LP’s records.
17. Memorialize lease agreements in writing. All real estate and equipment held by the LP (through an LLC) should have leases drawn up which are supported by billing invoices to the lessee (usually yourself or the business you own). This both supports the valid business purpose of the LP, the write-offs you may choose to claim (consult your accountant) for payments to the LP for such leases, and makes your accounting process much clearer.
18. File any required gift tax returns in a timely manner. While the planning we create is tax neutral, it does have incidental tax benefits and implications, including those pertaining to “gifting”, the transfer of a portion of your interest in the LP to a family member or other beneficiary. Should you choose to avail of these benefits, please do so with the guidance of a professional accountant familiar with such a process. A federal gift tax return utilizing IRS FORM 709 should be filed with your personal tax returns. Even if no tax is actually owed, the filing of such a return with full and proper disclosures may be of benefit, as it starts a 3-year statute of limitations, after which the IRS is precluded from challenging the valuation and assignment of said gifts.
19. Qualified tax and pension plans, such as IRA’s, should not go into your LP. These types of assets are usually referred to as “qualified plans or accounts” and often have tax benefits that will be negated by changing title away from yourself. Perhaps more importantly, this transfer will destroy the well established statutory protecetion those types of accounts and plans have in place by law.
This is meant to be a helpful introduction, the uses and benefits of the LP go far beyond what I have covered here. As always, call or email with specific questions or to see if this tool should be part of your personal planning.
A limited partnership is one part of a larger set of tools that forms an individually tailored system. The LP IS NOT a miracle cure that can answer all your problems and hold any kind of asset you care to stuff into it, contrary to what you might read on the websites of amateurs and LLC and LP mills that are not staffed by attorneys and which are rarely drafted for a particular purpose like ours are. Remember, there is no one size fits all plan in Asset Protection. Every plan must be tailored to your unique assets, exposures and business needs.
THIS IS NOT TAX ADVICE