Will a limited partnership or limited liability company protect my assets?
The family limited partnership is perhaps without peer in the asset protection area. In addition to the typical benefits provided by a family limited partnership (“FLP”) for income and estate tax purposes (e.g. shifting income to family members in lower brackets, creation of fractional discounts, maintaining control and management and simplifying annual exclusion and other gifting) a major benefit of an FLP is that if a family member is unable to satisfy a creditor, that creditor’s only remedy may be to receive a “charging order” against that family member’s partnership interest. Unless there has been a fraudulent transfer to the partnership, the creditor cannot reach the partnership’s assets.
One of the primary reasons for the use of FLP’s as an asset protection technique is that the creditors of an individual partner in the partnership cannot attach or levy the property of the partnership, unless the partnership also happens to be liable on the obligation in question. The creditor is limited to obtaining a “charging order” against the debtor-partner’s interest in the FLP.
A charging order obtained by a judgment creditor against the judgment debtor’s partnership interest only entitles the creditor to the rights of an “assignee” of the partnership interest; namely to share in the profits and surplus of the partnership, not to exercise the rights or powers of a partner. A judgment creditor, can get only a charging order under the Florida Revised Uniform Limited Partnership Act, and cannot foreclose on the partnership interest itself. A creditor who obtains a perfected security interest in the debtor’s limited partnership interest has priority over a later judgment creditor who seeks to obtain a charging order over the limited partnership interest.
It is generally believed that a judgment creditor who exercises the right to a charging order must pay income taxes on the profits and income attributable to the partnership interest, even if no income is distributed by the partnership, based on Rev. Rul. 77-137, 1977-1 C.B. 178. At the same time, it may be possible for the general partner of a family limited partnership to delay distributions to the partners and also take a reasonable salary for its services, thereby leaving the creditor with the charging order with “phantom income” on which the creditor must pay the income taxes. Thus, it is possible for a creditor with a charging order to have a quite undesirable asset.
The proper establishment and maintenance of an FLP can provide substantial estate and gift tax savings. An experienced estate planning or small business lawyer can help you be ensured that all appropriate actions have been taken to properly establish and maintain the partnership and other entities involved. Proper maintenance of an FLP can be achieved by following this checklist and should provide some assurance of securing both tax benefits and asset protection benefits for those utilizing the FLP as a planning tool:
1) Ensure that a separate account is established and continuously maintained in the name of the FLP and the corporation, and that the assets in such accounts remain separate from nonentity accounts (such as personal or trust accounts), and from account(s) of other entities.
2) The president of the corporation, the general partner of the FLP, should endorse all transactions involving the FLP; the president of the corporation should endorse all transactions involving the corporate general partner.
3) Establish and maintain a separate capital account for each partner of the FLP. An accountant should be consulted to establish and maintain such accounts.
4) Conduct annual meetings on behalf of the corporation pursuant to its bylaws to elect corporate officers and discuss corporate transactions. Such annual meetings should be documented in corporate minutes prepared and signed by the corporation’s secretary.
5) Maintain accurate records of FLP transactions as they occur and prepare an annual account of all FLP transactions for the given year to be maintained with FLP records.
6) Engage an accountant to prepare the appropriate tax returns for the FLP (Form 1065) and the corporation (Form 1120-S, assuming an S-election is made). Although the entities are treated as “flow through entities,” these returns are informational type returns that are required to be filed accurately and timely.
7) Ensure distributions from the FLP are made to the partners in accordance with their respective partnership percentages. Additions to the partnership should be made by the partners in accordance with their respective partnership percentages at the time of the addition.
8) Ensure personal obligations and expenses incurred by shareholders and/or partners are satisfied from such shareholders’ or partners’ personal accounts, never from entity accounts.
9) Ensure each entity remains active in its state of formation. Such active status should be maintained by payment of registered agent fees and satisfaction of any state tax requirements (i.e., payment of franchise tax, filing of annual reports, etc.) on a timely basis.
10) If the FLP agreement requires, ensure the corporation (as general partner) provides the appropriate FLP financial information to the limited partners, such as a balance sheet for the FLP, profit and loss statement for the FLP, federal and state tax returns, etc., as may be reasonably necessary for the limited partners to be advised of the financial status and results of operations of the FLP.
11) Limited partners may have reduced decision-making capacity with regard to the FLP; however, they are generally entitled to be apprised of the operations and maintenance of the FLP. Partners of the FLP and shareholders of the corporation should be advised to retain a portion of their assets outside of the FLP (i.e., in their revocable trusts and/or individual accounts). Such assets should be used for the partners’ and shareholders’ daily maintenance, expenses, gift giving, etc.
12) Ensure the FLP and the corporation are respected as true business entities. If the FLP and/or corporation engage in business transactions, all parties (family members included) to such transactions are required to abide by the appropriate transaction terms as evidenced in contracts, notes, etc. For example, payments of interest and/or principal on a note should be paid when due and, if not so paid, the appropriate interest and/or penalties should be calculated and collected.
If you need the assistance of an experienced asset protection lawyer to assist you with the establishment, maintenance and operations of a family limited partnership, please call The Coleman Law Firm, PLLC toll free at 1-866-510-9099.
A. Limited Liability Partnerships
There were significant changes that positively impact asset protection planning that were made to the Florida Revised Uniform Limited Partnership Act (Chapter 620.1101) and to the Revised Uniform Partnership Act (Chapter 620.81001) in 2005. The terms “Limited partnership” and “Limited liability limited partnership” mean an entity, having one or more general partners and one or more limited partners, which is formed by two or more persons and includes limited liability limited partnerships. (Chapter 620.1102)
A limited liability partnership is an entity a separate and apart from its partners. (Chapter 602.1104) An obligation of a partnership incurred while the partnership is a limited liability partnership, whether arising in contract, tort, or otherwise, is solely the obligation of the partnership. (Chapter 620.8306) A partner is not personally liable, directly or indirectly, by way of contribution or otherwise, for such an obligation solely by reason of being or so acting as a partner. (Chapter 620.8306) In a limited liability limited partnership, both general and limited partners are protected from liability and will not be held personally liable for an obligation of the partnership. (Chapter 620.8307) Partnership property is owned by the partnership as an entity, not by the partners as co-owners. A partner has no interest in specific partnership property that can be transferred, either voluntarily or involuntarily. (Chapter 620.8306) This form of ownership protects property owned by the partnership from the creditors of the individual partners.
B. General Partnerships
What protection is available through a general partnership?
A general partnership may become a limited liability partnership by obtaining a required vote of the partners, and then filing a statement of qualification with the Department of State. (Chapter 620.9001)
A limited liability partnership is defined as “a registered limited liability partnership registered under former §§620.78-620.789 . . . that has filed a statement of qualification under §620.9001 and has not filed a similar statement in any other jurisdiction.” This means that a partner in a general partnership can take advantage of the protection of a limited liability partnership once approved by the other partners and the statement is filed with the Secretary of State. An obligation incurred as a limited liability partnership is solely the obligation of the partnership. Fla. Stat., §620.8306.
A partner will not be held personally liable, directly or indirectly, by way of contribution, for such an obligation solely by reason of being or acting as a partner. A judgment creditor of a partnership may perfect a judgment lien but may not proceed against the assets of a partner to satisfy a judgment arising from a partnership obligation, unless the partner is personally liable pursuant to Fla. Stat., §620.8306.
C. Limited Liability Companies
Does a small business corporation (subchapter S) give me the same protection as a limited liability company?
Florida Statutes, Chapter 605, governs limited liability companies in Florida. A debt, obligation, or other liability of a limited liability company is solely the debt, obligation, or other liability of the company. A member or manager is not personally liable, directly or indirectly, by way of contribution or otherwise, for a debt, obligation, or other liability of the company solely by reason of being or acting as a member or manager. (Chapter 605.0304).
Any judgment creditor of a member of an LLC is limited to a charging lien and is typically not allowed any ownership interest in the member’s interest in a limited liability company. Pursuant to Fla. Stat. 605.0503
a judgment creditor’s rights are limited to a charging order on a judgment debtor’s transferable interest which requires the limited liability company to pay over to the judgment creditor any distribution that would otherwise be paid to the judgment debtor. One exception to this rule is that if a judgment creditor makes a showing that a charging order will not satisfy the judgment in a reasonable time, the court may order a foreclosure sale. Accordingly, if there is an intent to establish a single member LLC for purposes of simplicity in operations and for the LLC to be considered a “disregarded entity” for income tax purposes, consideration should be given to holding the ownership interest as tenants by the entireties between husband and wife to afford asset protection from the creditors of either spouse.
If you would like the assistance of a Florida asset protection attorney or estate planning lawyer to assist you with establishing a multi-member LLC to avoid creditor claims against the ownership interests of the partners in the LLC, please call us toll free at 1-866-510-9099.
D. Planning Considerations
There is virtually no reason, other than the potential desire for a public offering of the stock of a corporation, for any small business operation to use the corporate form of doing business any longer. The use of a limited liability company, electing to be taxed as an “S” corporation, provides substantial asset protection over ownership of corporate stock, and provides all of the advantages of a corporate form of doing business.
However, there are circumstances where the client may be disadvantaged by electing S status, where the use of a limited liability company will prove beneficial. Where it is expected that the business operation will incur substantial debt, or have significant operating losses, or will be acquiring highly appreciating assets, then an electing partnership tax treatment provides substantial asset protection, and significant income tax advantages.
Though there is no case law in Florida presently, it appears fairly certain that a single member LLC will not receive the charging order protections that a multimember LLC receives. Accordingly, if the simplicity of the single member LLC is desired, the ownership of the LLC should be titled in both spouse’s names as tenants by the entireties, to obtain protection against any individual creditors of either spouse.
The use of an LLC also avoids a new and serious problem faced by many C corporations (particularly professional and other personal service corporations) as a result of the case Pediatric Surgical Assoc., P.C. v. Comm’r, T.C. Memo. 2001-81. Pediatric held that profits derived from associate physicians in a medical practice are corporate profits and can only be distributed to shareholder physicians of the C corporation as dividends, thus imposing two layers of tax on the profits generated by the associates.
In light of Pediatric, it is important to address those professional and other personal service businesses operating as C corporations, which assumed they could successfully avoid double taxation by utilizing the strategy of “bonusing” sufficient amounts of compensation to physician shareholder-employees until the corporation’s income is reduced to zero. Until Pediatric, this strategy enabled the personal service C corporation to avoid double taxation. Pediatric, however, rendered this strategy unsound for personal service corporations typically used by physicians and other professionals.
For those business entities that wish to convert to an LLC, the complexity and tax impact of that conversion will depend on the current form of doing business. For a corporation that is currently taxed pursuant to an “S” election, the procedure is quite simple. IRC regulations provide that an LLC which-elected to be taxed as an S corporation can acquire and own an S corporation, and be treated for tax purposes as a single entity. Accordingly, simply establishing a new LLC electing to be taxed as an “S” corporation, capitalized with the stock of the existing S corporation, will result in an LLC “holding company” and wholly owned subsidiary that will be treated as a single entity. The result is that the existing business entity continues to operate as it has, but after the completion of the conversion, the owners have greater protection from their personal creditors than they had before the conversion.
With respect to C corporations, the procedure is not so simple, but the income tax impact should be analyzed from a cost/benefit perspective to determine whether the asset protection features of the LLC outweigh the cost of the conversion.
If you need a Florida asset protection attorney or estate planning lawyer to assist you with the conversion of an S corporation to a limited liability company to be taxed as an S corporation, please call us toll free at 1-866-510-9099.