January 19, 2010
Recession and Diminished Asset Values Offer Opportunities for Family Limited Liability Companies and Family Limited Partnerships
Family Limited Liability Companies (FLLCs) and Family Limited Partnerships (FLPs), have long been considered a method to protect and manage a family’s assets more effectively. However, in addition to those benefits, an FLLC or FLP offers several tax advantages, some of which are actually enhanced in the current economy while real estate and other personal property are at their lowest values in years. An FLLC or FLP is structured the same as any other limited liability company or limited partnership, except the members/partners are all family members. For an FLLC, there is a managing member and for an FLP, there is a general partner. Typically, the managing member of the FLLC or general partner of the FLP will own one percent (1%) of the entity, and control all of the entity’s assets. The remaining 99% of the FLLC or FLP is owned by others in the family. Once the FLLC or FLP is formed, investment assets of the family are contributed to the FLLC (or FLP), with each member (or partner) receiving a membership (limited partnership) interest. When properly structured, the parents still control all the assets as the officers and directors of the general partner (in the case of an FLP) or as the managing member (in an LLC), but the children ultimately own 99% of the entity through their partner/member interests. Asset Protection of the FLLC or FLP Asset protection occurs in a number of ways. First, the FLP or FLLC is now the owner of the assets, not the parents (or any other debtor). If the transfer was made correctly, the assets therefore cannot be attacked by a potential creditor of any individual member or partner. Second, depending on the state in which the FLLC or FLP was formed, a judgment creditor is entitled only to a charging order, and has no right to foreclose a debtor’s interest in the FLLC or FLP. A charging order gives a creditor the right to receive distributions of the judgment debtor partner when such distributions are made. However, along with the right to receive distributions is the responsibility to pay taxes on the debtor member/partner’s share of income which is generally very unappealing to the creditor. Estate Tax Benefits An ancillary benefit to the FLLC or FLP is that it can reduce, minimize or even eliminate estate taxes if done correctly. Using the structure outlined above, since the parents will be gifting member/partner interests over the course of a number of years, they will be able to do so in amounts at the maximum level allowed by the IRS without incurring any gift tax. The result is that the parents maintain control over the assets, while effectively transferring ownership of those assets tax free. Additionally, for evaluation purposes, the gift of an LLC or partnership interest is less valuable than the gift of the underlying assets. The rationale for the interest being less valuable is that there is a limited or no market for such interest which is subject to transfer and other restrictions as set forth in the operating or partnership agreement. It is not uncommon for discounts to be as much as 40% of the value of the underlying assets, and under certain circumstances, perhaps even more. Significantly, with the current recession, assets are at their lowest values in years. The current economic climate makes for ideal time to transfer real estate, stocks, bonds and other personal property into a FLLC or FLP, and gift the interests at a considerable savings to the family. The foregoing is only a very brief, general synopsis of how FLLCs and FLPs work. The are many legal issues to consider, and the IRS has attempted to attack transfers of certain FLLC or FLP interests. Whether the IRS is successful depends upon a number of issues. However, if structured and managed properly, an FLLC or FLP offers its investors the advantages described above, and many others beyond the scope of this article. For additional information, please contact Keith A. Krauss or Harry G. Kapralos. This alert is provided for educational and informational purposes only and is not intended and should not be construed as legal advice. It is recommended that readers not rely on this publication but that professional advice be sought for individual matters.