Understanding Family Limited Partnerships
The family limited partnership, created in 1916, has many unique attributes that are beneficial for both lawsuit protection and estate planning. With almost a century of case law surrounding it, the FLP has emerged as a tremendously powerful tool to protect real estate, equipment, bank accounts, and other assets against lawsuits. It also prevents lawsuits by making one so unattractive to a plaintiff’s attorney that he/she will choose not to pursue a lawsuit. In some situations (such as multiple rental properties), an LLC or single-member LLC will be used in conjunction with FLPs as part of one’s overall asset protection plan to hold certain assets for lawsuit protection.
FLPs are structured somewhat like a family business, with one or more general partners controlling the partnership. The “limited partners” have no control whatsoever. They receive income, which is determined and distributed by the general partner(s). The FLP is a pass-through entity, so it does not pay taxes.
Not all FLPs are created the same, however. Specialized attorneys have retooled the FLP to include lawsuit protection principles. Once your assets are properly structured in this way, you will have the financial peace of mind that comes from knowing you are protected from losing the assets you have worked a lifetime to secure.
If a lawsuit is filed against an individual who owns assets in his/her name and the plaintiff wins, the judge would issue a “turnover order,” in which non-exempt property, including the person’s home, cars, stocks, bonds, bank accounts, etc., could be turned over to the plaintiff to satisfy the judgment. However, if all of the person’s property is held within carefully-drafted asset-protection FLPs, the law in all fifty states absolutely prohibits any of that property from being seized, sold, or turned over. In fact, the terms of carefully-drafted asset protection FLPs give plaintiffs only one remedy to collect on their judgment: the “charging order.” This means that a plaintiff’s only right is to receive distributions from the family limited partnership.
Asset-protection FLPs contain a clause that enables the general partner to distribute income on a non-pro-rata basis, which means they can distribute income to themselves and other limited partners. They also have the ability to exclude distributions to the judgment creditor. As a result, the judgment creditor would receive no assets and no income; and because of the IRS Revenue Ruling 77-137, the judgment creditor who obtains a charging order against an FLP is required to pay taxes on “phantom income,” which is the income of the FLP, even if the plaintiff does not receive the income. The result is that the plaintiff does not obtain any assets or income, but is liable for taxes on the income they will never receive. Therefore, the disclosure of properly-drafted FLPs to a prosecuting attorney is a great deterrent to the filing of a lawsuit. Since many lawsuits are taken on a contingency basis, placing your assets into properly-drafted legal entities removes the financial incentive for prosecuting attorneys.
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