Many wealthy families in California would do well to consider the creation of family limited partnerships. These estate planning devices can be useful for asset protection, and they can also facilitate asset transfers at a tax discount.
First we would like to take a look at the asset protection that is afforded by family limited partnerships. If you were to be targeted by a creditor or litigant, your personal assets could be vulnerable if you do not take steps to protect them. This can also be a factor when you are going through divorce proceedings.
Resources that have been conveyed into a family limited partnership are protected from creditors and claimants. This is because of the fact that you are surrendering personal ownership of the property when you place it into the partnership.
However, you are not surrendering any control whatsoever. You as the general partner have complete rights of marketability and control. As a result, you could give yourself a salary, but you still do not technically own the resources that have been conveyed into the partnership.
It should be noted that distributions from the partnership could be attached if a creditor of some kind was to obtain a charging order. However, there is nothing that is compelling you to give yourself distributions.
In fact, there is quite a disincentive for the creditor to try to obtain a charging order. This is another nice thing about family limited partnerships. If no distributions are forthcoming to attach, the creditor will be empty-handed even though there is a charging order in place. However, this creditor would be responsible for income tax on income that was never actually received because no distributions were made.
You could create multiple family limited partnerships to shield your resources even further. For example, let’s say that you own an apartment building and a professional practice. You could place each of these assets into different family limited partnerships. Any action against one of them would not be applicable to the other.
Estate Tax Efficiency
A family limited partnership can facilitate asset transfers to your heirs in a tax efficient manner. As we touched upon earlier, you as the creator of the partnership act as the general partner. Your heirs would be the limited partners.
You can give the limited partners shares in the partnership. The gift tax would potentially be applicable when you give these gifts if they exceed the $14,000 annual per person exclusion.
However, the value of the gifts would be discounted for tax purposes. This is because of the fact that the limited partners have no rights of control or marketability.
Holding say 20% of something that you cannot liquidate or access in any way is not the same as having total control of this 20%. The Internal Revenue Service takes this into account when assessing the value of the gift.