Using Family Limited Partnerships to Protect the Family

 The last two decades have produced amazing changes in the law. Stable old concepts of asset protection and litigation prevention have given way to new ideas and methods. The limited liability company as an entity is new within the past three decades. The concept is to protect the family or a small select group of people from the risks of being entrepreneurs. Large companies have diversified their risk for years by dividing up their assets and their liabilities so that if an unanticipated liability appears, it can be controlled.

Choosing the correct venue to ensure that you receive the best asset protection provisions is very important. Where you set up your company matters. Make sure you have the charge order as the exclusive remedy against your family limited partenership. Further, family limited liability companies can provide protection from certain types of tax by using discounts for lack of a true market for the interests in the company. (After all, you have enough trouble working for your father– How can you expect someone else to?)

The concept of discounts for family limited partnership and limited liability companies has long been an accepted principle. It looks something like this if I am a client….. I set up a family limited partnership for many reasons: I want to maintain an investment structure; I want to make sure my family is protected from any liability; I want to ensure that my family is able to enjoy the fruits of my labor (which often caused me to miss baseball games, dance recitals and swim meets). I set up these companies to meet the needs of the legislature and follow the rules of the courts.

As an attorney, when I set these companies up there is a transformation in value of the company. The fair market value as determined by Wikipedia (not a very good source but an easy one to find),  is defined as an estimate of the market value of a property, based on what a knowledgeable, willing, and unpressured buyer would probably pay to a knowledgeable, willing, and unpressured seller in the market– a reasonable definition. In my practice I often ask people what their business is worth and I get endless explanations on how good or, less frequently, how bad their business might be based on what we are trying to do. If they are selling, it is worth the moon and the stars but if they are buying or getting taxed on it, they are struggling and may go under at any moment. So determining the fair market value of a company is often very difficult. I have thus become accustomed to having Certified Valuations completed to make that determination. A Certified Valuation is usually done by an independent Certified Public Accountant who carries the title of Certified Valuation Analyst, or CVA.

The importance of obtaining a Certified Valuation is for providing proof using independent analysis to determine the value of a company. This method has been very useful in the tax court. The judges (the people we hire and empower to determine the meaning and legislative intent of our rules and laws) like to see what an impartial expert believes to be the value. When a typical LLC or FLP is put together the result is lower value numbers for businesses because of the rules and restrictions on why units (partnership interests) can be transferred. The best way to complete this explanation is with an example from the client’s perspective:

• The FLP is put together for the reasons cited above. It has restrictions on marketability, control, transferability and leverage. We as the forming partners put those restrictions there to protect our family and each other.
• The FLP is capitalized with $1,000,000 in marketable securities and cash. The purpose of our company becomes clear:
• Allows continuity of investment;
• Allows asset protection, with charging orders;
• Allows management of the assets with managers;
• Allows diversity of ownership among family members;
• Allows continuity of taxation with efficiency for income tax purposes.

The above are all great reasons for putting together a FLP. But what happens to our $1,000,000 in marketable securities and cash? Since the partnership has restrictions on it for marketability, control, transferability, and leverage, if we were to sell it for fair market value how much would a willing buyer pay for it? How much would you pay for a company from which you could not receive any money unless someone else gave it to you?– You could not sell it unless someone else agreed?– You could not pledge it to obtain a loan without third-party approval? When our CVA takes a look at it, he/she will apply a discount because of those restrictions. The discount is generally between 15% and 25%. I have, however, seen it go as high as 40% because the underlying assets were particularly difficult to value or sell.

Why is this important? It just so happens that if a discount is applied to a valuable estate, that discount may reduce the transfer tax which the IRS takes from you as an estate tax. If the above situation applies and you obtained a 20% discount you would have saved nearly $80,000 in estate tax. You get to keep your money.

The IRS is now attacking these discounts so that they can raise taxes by doing away with the judicial interpretations of the law and the legislative intent of your elected officials. Common sense dictates that we use evidence. This nation was intended to be governed by a rule of law, not of people. The IRS wants to take more of your money and they want to take years of losing case after case off the books, leaving   you exposed.

Al Hehr, III is a member of the Estate Planning practice group at Meyers Roman. He can be reached at AHehr@meyersroman.com or 216-831-0042.