Asset Protection

Family Limited Partnership (FLP)

A family limited partnership is a regular limited partnership that happens to have family members involved. You create the partnership to accomplish certain business purposes, such as consolidation of family wealth or teaching younger generations how to manage wealth. In return for partnership interests, you transfer your assets into the partnership.

A partnership must have at least two partners. In most family limited partnerships, there is a general partner and limited partners. The general partner manages and controls the partnership. The limited partners have no control. The partnership terms are memorialized in a written operating agreement.

Typically, you control the general partner. On occasion, you will not wish to control the general partner, and we will discuss the reasons for that with you. Often, you will own limited partnership units, and you use these units to gradually gift limited partnership interests to younger generations. Control stays with you (because you control the general partner), while wealth moves out of your estate.

Because of the way the partnership operating agreement is written, the limited partners have very little ability to transfer ownership. This is helpful in many ways. First, in case of divorce, the soon-to-be-ex may have claim to the value of the partnership units, but will have a hard time actually getting the units. Second, because the units are difficult to transfer outside of family, the units very often qualify for a discount for lack of marketability. Third, because they are limited partnership units, and the general partner is in control of the partnership, the limited partners have no control. The limited partnership units typically are appraised with a discount for lack of control.

How does this work for your benefit? Let’s assume that your partnership owns as an investment a share of IBM stock that is selling on the stock market for $100. Anyone could buy a similar share of IBM via the stock market. If you offered an investor the opportunity to buy the stock on the stock market, the investor would pay $100 for it. If you offered the same investor the opportunity to buy a unit of limited partnership interest equivalent in value to the share of IBM stock, the investor would not be willing to pay $100 for it. Why? Because the investor knows that the share of IBM stock comes wrapped in a package that includes dealing with someone else’s family, as well as an onerous partnership agreement. The limited partnership unit has limited marketability, no control, and family drama. How much is the discount? That depends on an appraisal by an independent, qualified business valuation analyst. However, discounts of 10% to 40% or sometimes even higher are not unheard of.

Why does this benefit you? Let’s say that you have gifted to your son 20% of the limited partnership units in your family limited partnership. The assets of the family limited partnership include $1 million of IBM stock. Logically, your son’s wife would think that your son is worth $200,000. However, if your son’s wife were to initiate divorce proceedings against your son, the assets would have to be valued to be split up. Imagine her disappointment when the appraisal for the partnership showed that your son’s limited partnership units were worth merely $140,000 due to a 30% discount for lack of control and lack of marketability.

And it gets better! Let’s assume instead that your son was at fault in a car accident. This is an outside liability, meaning it did not occur within the confines of an entity. The injured party sued your son, went to trial, and won a $1 million dollar judgment against your son. Perhaps your son is very handsome, absolutely charming, a great tennis player, but not much of a go-getter, and the only asset your son owns is the 20% of the limited partnership units in your family limited partnership that you gifted to him. The assets of the family limited partnership include $1 million of IBM stock.

Logically, your son’s creditor would think that your son is worth $200,000, and would want to take ownership of the limited partnership units away from your son in partial satisfaction of the judgment against your son. However, the injured party cannot take title of your son’s limited partnership units. Instead, your son’s creditor would have to go back to court to get something called a “charging order”. A charging order is a piece of paper that says in essence, “Dear General Partner. Son owes me money. Instead of writing distribution checks to Son, please write them to me instead. Sincerely, Injured Party.”

You as General Partner are in charge of what? Determining distribution checks! So, while the charging order is valid, what do you do? Don’t write distribution checks to your son!

Does this mean that no money can come out of the partnership while any limited partner has a charging order against him/her? No. You as general partner may loan money, borrow money, pay wages, sell assets, buy assets-there are many ways to get money out of a partnership. You just don’t want to make a distribution, because if you did, your son’s pro-rata share would have to be paid to your son’s creditor.

As a partnership, under US Federal income tax law, your partnership files each year an informational income tax return known as Form 1065. The partnership pays no income tax itself, but is considered a “flow-through entity”. The Form 1065 has attached to it Forms K-1. Each partner gets a K-1 that reflects his/her income tax from the activities of the partnership. Each partner includes the numbers from the K-1 on his/her personal income tax return, Form 1040.

And here is the part where you may stand up and sing. While the judgment creditor holds a charging order against your son, your son’s judgment creditor gets your son’s K-1, and your son’s judgment creditor has to include on his 1040 the income tax items as a result of the activities of the partnership. In other words, although the judgment creditor is not getting any cash flow because the general partner is not writing distribution checks, the judgment creditor will have to pay income tax on income attributable to your son from the family limited partnership.

What does this mean in the big picture? If you have your family wealth tied up in a family limited partnership, it will be much easier to convince creditors or predators to settle immediately for whatever cash you offer them rather than fight in court. Personal injury attorneys are less apt to take on as a client someone who wants to sue you. If the personal injury attorney does take the client, he/she likely will counsel the injured party to settle, and quickly. The personal injury attorney knows that his client will be the most unhappy person in the world if the client goes all the way through trial, wins the trial, goes back to court, gets a charging order, and then, instead of getting cash, sits around waiting, and at the end of the year gets a K-1 that means he has to pay income tax to the IRS. The personal injury attorney’s client now has lost money by winning-and the personal injury attorney, who most often gets a percentage of the winnings, has been paid nothing.

This has been a gross simplification of an area of law that is onerously complicated. Partnerships are expensive to set up, expensive to maintain, and require constant care and feeding. If you do not have the time, energy, and money to do your partnership right, then choose a different law firm. Family limited partnerships are one of our most gratifying practice areas, but we have strict maintenance expectations. We, as your attorneys, your CPA, and you have to work together as a well-oiled machine to build and maintain your partnership to withstand assault. A poorly-maintained partnership is next to useless.

Limited Liability Company (LLC)

Limited Liability Companies are a fairly new legal development, and a great addition to our asset protection arsenal. A limited liability company (LLC) is an entity under state law that offers limited liability to its owners (known as members), but also allows maximum flexibility under federal income tax law, as an LLC may choose to be taxed as a disregarded entity, a sole proprietorship, a partnership, a C-corporation, or an S-corporation.

Florida passed its first LLC statute about twenty years ago, but until clarification of the statute occurred about ten years ago, LLCs did not get much use in Florida. Not all states allow LLCs.

LLCs may be member-managed, or manager-managed. We typically prefer manager-managed LLCs for asset protection purposes, because the operating agreement clearly states that various and sundry members have limited liability and no control, and that only the manager may bind the LLC. Member-managed LLCs may confuse creditors and predators into thinking that any member may control the LLC.

LLCs are unique in that they offer charging order protection under Florida law similar to a partnership, but do not lock the LLC into Subchapter K (partnership) taxation under federal law.

What is a charging order and how does it protect you? Let’s assume that your daughter was at fault in a car accident. This is an outside liability, meaning it did not occur within an entity. The injured party sued your daughter, went to trial, and won a $1 million dollar judgment against your daughter. Bless her heart, perhaps your daughter is lovely, absolutely charming, kind to children and pets, but is not much of a go-getter, and the only asset your daughter owns is the 20% of the limited liability company units that you gifted to her. The assets of the LLC include $1 million of rental real property.

Logically, your daughter’s creditor would think that your daughter is worth $200,000, and would want to take ownership of the LLC units away from your daughter in partial satisfaction of the judgment against your daughter. However, the injured party cannot take title of your daughter’s LLC units. Instead, your daughter’s creditor would have to go back to court to get something called a “charging order”. A charging order is a piece of paper that says in essence, “Dear Manager of the LLC. Daughter owes me money. Instead of writing distribution checks to Daughter, please write them to me instead. Sincerely, Injured Party.”

You as Manager are in charge of what? Determining distribution checks! So, while the charging order is valid, what do you do? Don’t write distribution checks to your daughter!

Does this mean that no money can come out of the LLC while any member has a charging order against him/her? No. You as manager may continue business as usual. You may pay the mortgage on the property in the LLC, pay the real estate taxes, collect rents, loan money, borrow money, pay wages, sell assets, buy assets-there are many ways to get money out of an LLC. You just don’t want to make a distribution, because if you did, your daughter’s pro-rata share would have to be paid to your daughter’s creditor.

If your LLC is taxed as an S-Corp or as a partnership, under US Federal income tax law, the LLC files each year an informational income tax return known as Form 1120-S for an S-Corp or a Form 1065 for a partnership. The LLC pays no income tax itself, but is considered a “flow-through entity”. The Form 1120-S or Form 1065 has attached to it Forms K-1. Each member gets a K-1 that reflects his/her income tax from the activities of the partnership. Each partner includes the numbers from the K-1 on his/her personal income tax return, Form 1040.

And here is the part where you may stand up and sing. While the judgment creditor holds a charging order against your daughter, your daughter’s judgment creditor gets your daughter’s K-1, and your daughter’s judgment creditor has to include on his 1040 the income tax items as a result of the activities of the LLC. In other words, although the judgment creditor is not getting any cash flow because the manager is not writing distribution checks to the members, the judgment creditor will have to pay income tax on income attributable to your daughter from the LLC.

What does this mean in the big picture? If you have your family wealth tied up in a LLC, it will be much easier to convince creditors or predators to settle immediately for whatever cash you offer them rather than fight in court. Personal injury attorneys are less apt to take on as a client someone who wants to sue you. If the personal injury attorney does take the client, s/he likely will counsel the injured party to settle, and quickly. The personal injury attorney knows that his client will be the most unhappy person in the world if the client goes all the way through trial, wins the trial, goes back to court, gets a charging order, and then, instead of getting cash, sits around waiting, and at the end of the year gets a K-1 that means he has to pay income tax to the IRS. The personal injury attorney’s client now has lost money by winning-and the personal injury attorney, who most often gets a percentage of the winnings, has been paid nothing.

LLCs may have only one member. However, single member LLCs (SMLLCs) may not offer the asset protection that the owner expects. Do not count on an SMLLC for asset protection!

First, the public policy of a charging order is predicated on protecting the interests of the innocent member. If there is only one member, there is no innocent member to protect. Judges may (and have in other states) disregard the entity entirely and look to the member individually to satisfy creditors. Second, SMLLCs very often choose to be taxed under federal income tax rules as disregarded entities. Our experience is that SMLLCs very often do not bother to open up their own bank account. They do not separate their operations from that of the single owner. They do not have annual meetings, do not produce financial statements on a regular basis, and in general, do not respect any of the formalities of an entity. If you do not respect your entity, why should the courts? And if the courts do not respect the entity, the lawsuit has now just breached the LLC veil, opening up your personal assets to collection in the lawsuit. Finally, an LLC does not offer an individual person protection from the individual’s negligent acts. If you are the single member in an SMLLC, and you do something negligent or heinous, no LLC in the world is going to shelter you.

Remember also that, for an inside liability, a creditor may attach the assets within the LLC. We often will suggest nested LLCs, or multiple LLCs, to limit the amount of assets available for an inside creditor. For example, if you have three rental properties, we most likely would recommend that each piece of real property be placed in its own LLC, and that the management operations for handling the rentals be placed in a fourth entity. If someone slips and falls on property two, he/she only would be able to take property two, not property one or three, and not the cash that maintains the properties.

Family Limited Liability Company (FLLC)

Family Limited Liability Companies (FLLCs) are a new asset protection product, offered as a substitute for Family Limited Partnerships (FLPs). We see a bright future for FLLCs. However, due to the newness (in legal history) of FLLCs, we do not recommend them as a substitute for FLPs. We can be fairly sure how a judge will react, asset protection speaking, to a FLP action. They are tried and true. We do not have that security with a FLLC. When you are looking for asset protection, you should stick with the equivalent of sturdy flannel pajamas.

Our professionals may assist you with the formation of a limited liability company (LLC). We offer services to establish the business entity as well as ongoing maintenance to ensure its viability. We prepare annual updates and help keeping your LLC in compliance with the law.

Professional Liability Company (PLC)

If you are a dentist, architect, engineer, doctor, lawyer, CPA or other professional, you may benefit from establishing a Professional Liability Company (PLC). A PLC is a limited liability company that is organized for the specific purpose of rendering professional services. Its members are other limited liability companies, professional corporations, or individuals who themselves are licensed or otherwise legally authorized to render the same professional service as the limited liability company. PLCs offer many of the benefits of LLCs. However, remember that a PLC does not indemnify you as a professional from your professional negligence. We establish the business entity for you and ensure its validity by preparing annual updates and keeping you in compliance with the law.