Examine FLPs Under a Court Microscope

Ed Rabinowitz

Physician's Money Digest, July31 2004, Volume 11, Issue 14

Wall Street Journal

Family limited partnerships(FLPs) have been popular estateplanning and asset protectiontools for many years, enablingparents to leave large sums of money, virtuallytax-free, to their children. However,according to a report, a recent US Tax Court decisionhas thrown a wrench in the works.

The Complete Book of Money

According to Stephen Pollan, authorof (Harper Collins; 2000), FLPs are goodtools for people with taxable estatesbecause they enable couples to curbestate and gift taxes. Parents can transferassets to their heirs, usually theirchildren, without losing control of theassets. Parents name themselves as generalpartners, with their children as limitedpartners. This allows the parents tocontinue to make investment and managementdecisions. However, the taxcourt ruling may change all that.

Focusing Further

Journal

According to the article, thetax court found that a now-deceasedTexas businessman had maintained toomuch control over his partnership, includinghow income was distributedamong the partners. The court threw outthe FLP, resulting in a $2-million tax paymentfor the businessman's heirs. Theestate has appealed the ruling.

Meanwhile, in the wake of the taxcourt decision, attorneys are encouragingtheir clients to revisit and rethinkthe structure of their FLPs. The articlenotes that attorneys are recommendingthat clients reduce or relinquish controlof the partnership assets. This can beaccomplished by naming either theirchildren or an independent thirdparty—such as an attorney, bank, orseparate trust—as the general partner.

Attorneys say that taking these stepswill enable the partnerships to stand upunder intense scrutiny from the IRS. Butit also means parents will have less controlover the assets, and that loss of controlis not easily waived. Some attorneys,however, are taking a wait-and-see attitudepending the outcome of the appeal.Others are still bullish on FLPs, notingthat if they're structured correctly, theycan endure the challenge of the IRS.

Another promising sign, the articlenotes, is that the tax court recentlyupheld another FLP challenged by theIRS. That's good news for physicians,because asset protection is another benefitof an FLP. Assets held by the partnershipare difficult for creditors to pryloose without a court order.

Pondering Points

Since physicians are leading candidatesfor FLPs, they should consider thefollowing key points to setting up anFLP that will not wilt under the heat ofan IRS investigation:

  • Set up the partnership whileyou're in good health. Make it a legitimatebusiness, not just a late-in-lifeploy to avoid taxes. Also, create a separatebank account.
  • Do not put personal assets like yourhome into the partnership. Rather, use thepartnership to pool investment assets,such as stock or real estate, or to managean existing family business.
  • Do not use assets in the partnershipto pay for things like rent or medicalexpenses. Do distribute income topartners based on their percentage ofownership when the partnership's assetsperform well.

FLPs are rather expensive to set up,costing from $5000 to $30,000. But itwill be well worth the money if the partnershipis on solid ground with the IRS.Otherwise, it could get even more expensivefor your heirs.

FLPs—Right Reading

Asset Protection for Physicians andHigh-Risk Business Owners: How toProtect What You Own from Lawsuitsand Claims

Physician's Money Digest

For more information on familylimited partnerships, pick up a copy of ($14.95; Francis O'Brien &Sons Publishing Co, Inc; 2002), byRobert J. Mintz, a practicing attorneyand a nationally recognized expert inasset protection and tax planning. readers canobtain a complimentary copy of thebook or get more information at 760-967-7748 or www.rjmintz.com.