The use of the Limited Partnership has gained popularity over the past 25 years as a way to limit liability and reduce exposure and risk, as well as a tax and estate planning tool. Like any other trading or investment tool, it can be used correctly for its intended purpose, or it can be used incorrectly, which can lead to problems.
PRACTICAL LESSONS LEARNED
Although the limited partnership has been adopted in every state in the US, not all limited partnership statutes are the same. Some are much better than others, and some are worse. It is important to comply with the requirements of state law, remembering of course that some states have much more formality requirements than others. Here are some helpful suggestions.
- Preferably, make use of those jurisdictions where the LP statute is No invasive of the privacy of all partners. Some states want the name and address of each partner, even if they are not the general partner (manager). Other states are much more respectful of privacy and only require the contact information of the general partner.
- Be sure to file any annual reports. In the best jurisdictions, this is typically just a statement of who the general partner is, along with their address. In others, it is more detailed and requires a financial report.
- Use the Limited Company for its intended and proper purpose. You must have a ‘business objective’, that is, to control and maintain investment assets such as stocks in corporations, ownership interests in limited liability companies, business investment accounts, mutual funds, etc.
- The limited partnership should not be treated like your personal piggy bank. Make sure the Association Agreement establishes one or more specific and well-written business purposes.
- Have the Partnership Agreement drafted by a licensed attorney with experience in this area of law. There are business entity registry providers (incorporators) who don’t know what they are doing and tend to provide a ‘generic’ agreement which is a serious disservice to their clients.
AVOID IRS PROBLEMS
A series of IRS cases (the strange cases) examined the misuse of Limited Partnerships, particularly regarding their misuse by claiming large tax breaks where the founder of the Partnership essentially treated the assets of the Partnership as his own despite claiming to transfer them to the FLP. To avoid problems with the IRS, here are some ‘lessons learned’ to consider:
- Do not establish an FLP primarily for tax reasons. That is not a legitimate ‘commercial purpose’. If it does, it only asks for trouble.
- The IRS considers it abusive to put all your personal assets in the Company. Maintain a sufficient amount of funds and accounts outside the Association to provide for your lifestyle.
- The cost of managing your estate must be paid from your living trust or personal financial accounts, No Outside of the Limited Company. The same goes for estate taxes. It may be prudent to carry a sufficient life insurance policy to cover anticipated estate taxes. That should be kept separate from your family society.
- It is highly unexpected to put your personal residence in the family limited partnership. The IRS can easily consider you abusive. In it strange In this case, the IRS was highly critical of Mr. Strangi occupying the house without paying rent after the house was transferred to the Limited Partnership. Obviously, the same would be true for other “personal use” items, such as boats, art collections, and vacation homes.
LIMITED PARTNERSHIP ADMINISTRATION
One of the areas where problems can arise is in the proper administration of the FLP. This includes not only the daily operations, but also the financing of the Association. For example:
- Change the title of the assets destined to be owned by the FLP. Failure to do so means that the asset is No actually included in the Partnership, even though the Partnership Agreement may include the asset in its initial ownership list of the partnership. Changing the title means more than just including an item in a list. Trading accounts at a brokerage firm, for example, may require you to close the old existing account and open a new one, in the name of the limited partnership.
- The real property you intend to transfer to FLP must be retitled by means of a deed conveying the property and registered with the Recorder in the county where the property is located.
- If there is any confusion about which assets belong to the Limited Partnership itself and which belong to the persons or entities that are the limited partners, such confusion should be clearly resolved with a traceable and auditable paper record.
- Avoid using assets belonging to the Limited Partnership for purposes other than those stated in the business purpose section of the Partnership Agreement.
- Keep accurate books and records, and have a paper record that is clear and unambiguous. The Limited Company’s books and records must be kept in an orderly and efficient manner that reflects attention to detail and your intent to manage the Company fairly and commercially.
- When distributions are made, they must be equitable and fair. Unless there is an agreement signed by the Partners to make unequal distributions that favor one partner more than the others, distributions must be allocated among the Partners on a pro rata basis equal to their percentage interest in the Partnership (i.e. their ownership percentage).
- Funds being held inside The partnership must be reinvested for the good of the limited partnership as a whole, not for personal use as a piggy bank for a partner.
- Properly drafted Partnership Agreements owe certain rights to the limited partner, such as the power to replace the General Partner and Amendment rights to the Partnership Agreement.
- The general partner should be expected to make an annual limited partnership report. This is different from the annual filing required by the Secretary of State. This Limited Partnership Annual Report is from the General Partner to the Limited Partners and serves as a report card on how the Partnership is doing financially with their holdings and investments. You should highlight any changes (positive or negative) and any upcoming business opportunities, as well as establish a cash flow statement and balance sheet for each Partner to review.
- If a family’s limited partnership is created close to the founder’s death, and if the founder contributed most of the partnership’s assets at that time, this can be open to attack by the IRS and likely to be successful. It is best to form a family limited partnership for proper business purposes (ie managing investments, company stock, mutual funds, etc.) and properly document the timely and proper management of the limited partnership with accurate books and records.
It is important to ‘walk the walk’ and not just ‘talk the talk’. A limited partnership that is properly drafted, has a business purpose, is run on a commercial basis, and is established well before the death of the founder has a much better chance of withstanding any audit and proving to be an example of ‘how to do it right’.
© Michael L. Potter – All rights reserved. This article may be reprinted with permission from the author.
