The family limited partnership (FLP) has been touted as a powerful tool for estate planning and for managing family wealth. In theory, assets that are otherwise attractive to a creditor become unattractive once transferred to an FLP, because after the transfer, the limited partners own partnership interests, rather than the specific assets themselves.
Under many state partnership laws, the only remedy generally available to a creditor against a partnership interest is in the form of a charging order by a court. A charging order is considered a limited remedy, in that the creditor’s interest against a partner is limited to distributions of income or principal made from the partnership.
Since the general partner, who is a family member, determines the timing and amount of distributions, the creditor’s ability to gain satisfaction under a judgment may effectively be blocked.
While this mechanism does provide significant asset protection, it would be unrealistic to think that the creditor protection feature of an FLP is absolute. Here are some circumstances under which the asset protection benefit could be compromised:
o If assets placed within the FLP have inherent liabilities associated with them, they could generate a liability within the family limited partnership, thereby subjecting partnership assets to the claims of a creditor.
o If a court deems the creation of the FLP was for the sole purpose of protecting assets, it may not limit the creditor’s remedy to a charging order.
o If the general partner is a corporation, a judgment creditor of that corporation may indirectly gain control of the FLP by gaining control of the corporate general partner.
By using a family limited partnership, an estate owner generally gives away limited partnership interest, possibly reducing the size of his or her estate for estate tax purposes, while retaining control of the operation of a business.
However, because of the overly aggressive use of FLPs, the Internal Revenue Service (IRS) and some courts have begun taking a harder look at the formation of FLPs. If you currently have or are considering forming an FLP, it is important to consult a qualified tax and legal professional to help ensure your planning is consistent with your goals and objectives.