What is a Family Limited Partnership?
A family limited partnership follows the framework of a standard limited partnership, applying it to a family business situation. Essentially, family limited partnerships are holding companies owned by at least two members of a family. The purpose of the partnership is to allow families, especially ones possessing significant wealth, to retain and protect their assets by safeguarding them from creditors while allowing for a potential reduction in tax liability upon the transfer of wealth.
Assets held in an FLP may include homes, businesses, real estate, intellectual property, cash, bank accounts, brokerage accounts, stocks, and bonds. Individuals with significant wealth are also likely concerned about protecting the other high-value personal assets they own such as cars, boats, jewelry, art, and other collector items. These assets can also be protected in a family limited partnership.
In a family limited partnership, members of a family are able to combine funds into a business by buying shares of that business. Each family member will profit from the business in proportion to the amount they have invested into it.
FLPs offer statutory protection, meaning they are codified by law. Under the Revised Uniform Limited Partnership Act (RULPA), implemented in all 50 states, assets owned in a limited partnership are not owned by individual partners. Because the partners technically have no attachable assets, they are protected from attack by creditors.
The term “creditor” can refer to actual creditors and probable creditors such as ex-spouses, business partners, and almost anyone the business owner might know. A government agency, such as the IRS, can even be considered a creditor.
How do Family Limited Partnerships Work?
There are two types of partners in a family limited partnership: general partners and limited partners. General partners have control of the partnership business. General partners are typically a business-owning couple seeking to eventually transfer ownership of assets or the entire business to their children or grandchildren. Sometimes we structure the general partner as an entity, for example, a limited liability company that is owned by two parents.
General partners are responsible for overseeing daily operations such as managing cash deposits and investment transactions. They have complete decision-making authority over the partnership, including whether or not to distribute profits or dissolve the FLP if desired.
Limited partners, on the other hand, are not given any management responsibilities or decision-making authority. They are essentially “silent” partners or passive investors. Limited partners own an interest in the business for which they can receive distributions of profits generated by the family limited partnership. Limited partners are typically the children or grandchildren of the general partners who own the business. Often times we put the children or grandchildren’s interest in a Children’s Trust, which is a type of asset protection trust. In this instance, it would actually be the Children’s Trust that would be the limited partner.
In a well-drafted limited partnership, Limited partners do not have the authority to sell or assign their partnership interests without consent from the general partners. They are also unable to force the liquidation of the FLP. Essentially, the general partners are in complete control of the FLP, despite not technically owning the assets in the partnership.
What are the Benefits of a Family Limited Partnership?
One of the most appealing elements of a family-limited partnership is the additional liability protection for each of the partners. Because individual partners do not own assets in an FLP, a partner is less likely to be the subject of a frivolous lawsuit or come under attack from creditors. Because the partner is “uncollectible”, this is part of the asset protection strategy that helps to ward off claims.
In addition, family-limited partnerships allow business-owning families to preserve their wealth by easing the transfer from one generation to another without giving up control of the underlying property and assets in the partnership. General partners can also gift entire businesses to their descendants, ensuring the company remains in the family partnership’s control in the future.
Families have been using FLPs for decades to maintain generational wealth, much in part due to the tax benefits they offer. For example, partners can gift FLP interests free of taxes up to the same amount as the annual gift tax exclusion—currently at $15,000 per person for individuals and $30,000 per person for married couples. Assuming the gift tax exemption rate holds steady, partners can transfer significant wealth by gifting it to several members of a younger generation year after year, free of taxes.
General partners can also receive an approximate 25% discount to fair market value by transferring their business and investment interests into an FLP and gifting LP interests to their descendants. For instance, suppose a couple who owns a business worth an estimated $20 million and also holds investments and other assets worth roughly $10 million, puts all of these assets into a FLP. The combined total of their assets, $30 million, would be well over the $23.4 million lifetime gift tax exemption for couples currently in place, meaning almost $7 million of their assets would be taxed at a rate of approximately 40% upon their death, or approximately $2.8 million in estate taxes.
By gifting 99% of the interest in the FLP to their children as limited partners, and by applying a 25% discount to the value of the partnership due to the lack of marketability of the limited partner interests and the lack of control over the limited partnership, the $30 million value can be reduced to approximately $22.5 million and the $2.8 million estate tax can be eliminated.
In addition, future returns are excluded from estate taxes. Once assets in an FLP are gifted, say to a couple’s children or grandchildren, they effectively cease to be a part of the couple’s taxable estate, meaning any future returns will not be subject to estate taxes. For instance, in the above example, if the $30 million grows to $60 million by the time of the death of the second to die between the husband and wife, there is still no estate tax on the $60 million. This is an excellent asset protection an estate tax planning tool for anyone with a business, real estate, or investment portfolio expanding rapidly or generating significant profits.
General partners can also establish guidelines to prevent the misuse of gifted FLP interests. If so desired, they may stipulate that gifted shares may not be transferred or sold before the beneficiary reaches a specific age.
Charging order protections also offer general partners an added layer of security if a descendant behaves irresponsibly with FLP shares. Charging orders limit a creditor’s ability to go after assets owned by the FLP. They are instead limited to the debtor’s share of any distribution of funds made by the FLP and blocked from accessing the underlying property within the partnership.
General partners are the only partners with authority over distribution and may decide not to distribute for one reason or another. Such as when a person has brought a claim against you and won, now they are your judgement creditor. The IRS requires a judgment creditor to pay taxes on the partner’s share of profits, whether those profits are distributed or not. Often, in this situation, Plaintiffs would rather negotiate a settlement for pennies on the dollar than pay tax on profits that may never be distributed.
How can Trucking and Transportation Business Owners use Family Limited Partnerships to Their Benefit?
A common asset protection strategy used by those in lucrative professions such as large-scale trucking operations, is the segregation of high-risk assets from low-risk assets.
An individual with significant wealth is likely to have multiple and varied assets such as homes, investments, real estate income properties, various business interests and partnerships, intellectual property, bank accounts, brokerage accounts, and so on. These assets are not necessarily at equal risk, so it’s helpful to classify them based on which are the most likely to be attacked by creditors. As a general rule, high-risk assets are best kept separate from lower-risk assets, and high-risk assets should be kept in separate FLPs from one another to minimize potential liability exposure.
For example, if someone were to be injured at a rental property and subsequently sued the FLP as the property owner, the assets held in a different FLP would not be accessible to the creditor.
Having your assets held in FLPs is also an effective preventative measure to achieve asset protection for your many forms of assets. Suppose a plaintiffs’ lawyer realizes the chances of collecting are slim due to your FLP which was created years before the instant issue arose. In that case, the attorney is more likely to take an insurance company’s offer and settle their claims rather than pursue litigation, saving you the potential headache and expense of a lawsuit. Even with a court judgment, it often wouldn’t make sense to pursue collection as the judgment would be uncollectible.
Creditor Attacks Against Transportation Industry Owners are at an All-time High
Owners of trucking businesses are increasingly becoming the targets of predatory lawsuits. Due to a sharp rise in what are known as “nuclear verdicts” – jury awards exceeding $10 million – creditors are extorting massive amounts of money from transportation and trucking business owners. Combined with the huge hit from the COVID-19 pandemic—more than 3,000 trucking companies went out of business in 2020—the trucking industry is effectively under attack.
According to the American Transportation Research Institute, the average verdict size for a lawsuit above $1 million involving a truck crash has risen from $2.3 million to $22.3 million from 2010 to 2018, nearly a 1000% increase. This means that just one bad accident could put a trucking business on the verge of bankruptcy. And unfortunately, juries in the courtroom have been known to side with the plaintiffs, even in accidents when the passenger vehicle was not clear of fault.
There was a catastrophic trucking accident in Odessa, Texas, where a pickup truck driver lost control of their vehicle during a winter storm. The pickup truck crossed the median, hitting a tractor-trailer. The accident killed a 7-year-old passenger in the pickup truck and left his sister with severe brain injuries. The pickup driver’s family subsequently sued Werner, the tractor-trailer company, and was awarded $90 million. The settlement was the biggest in the company’s history.
Accidents like this are incredibly unpredictable and may not be a truck driver’s fault, yet they can result in bankruptcy for both the transportation company and its owner. To make matters worse, nuclear verdicts are driving up the cost of insurance for trucking companies. In response, large and small operators alike may have no choice but to forego excess insurance, putting them at greater risk if they are involved in an accident. The reason is clear as to why trucking company owners must proactively secure assets in a family limited partnership.
Don’t Wait to Set Up a Family Limited Partnership
Establishing an FLP early on is not only essential to protect yourself from litigious individuals, but advanced planning is the best protection to stop future lawsuits in their tracks.
Setting up an FLP in an attempt to protect yourself against pre-existing creditors may be taken as an improper attempt to obstruct creditor claims. If you are already facing a lawsuit or know that one is imminent and then you act to set up an FLP, the creditor may argue that you established an FLP fraudulently to avoid paying debts.
Likewise, it’s helpful to incorporate FLPs into a comprehensive estate planning, asset protection, and tax planning strategy. If your FLP is incorporated into a complete tax, estate, and financial plan, creditors will have little ground to argue that the FLP was established fraudulently in an attempt to evade creditor claims.
Keep Control of Your Assets, and Your Next Steps
Storing assets in an FLP allows transportation business owners the ability and freedom to safeguard assets from creditor attacks while maintaining control of your assets. With jury trials decimating entire trucking companies and handing over multimillion dollar settlements, it’s time for you to be wise and protect your livelihood while you still have the opportunity.
Maintaining a family limited partnership and the related tax laws are incredibly complex, so it’s advisable to seek the counsel of an experienced attorney who can orchestrate the many critical elements to your plan. If you own a successful or rapidly growing trucking or transportation-based business, reach out to the attorneys at Sollertis.
Our clients who have families greatly benefit from protecting their assets using family limited partnerships. Your business and how you operate personally is unique, so let’s craft an asset protection plan that fits your personal style and meets your specific needs. Speak with a Sollertis asset protection lawyer to map out your best path forward today.