Partnerships

Another income producing-asset protection plan
which has had some acceptance in the United States is
the so-called "family limited partnership" which sounds
appealing but is hardly without legal and tax problems.
Recent U.S. court decisions have called into question
some fundamental advantages of the family limited
partnership including its greatest attraction,
insulation of partnership property from an individual
partner's personal creditors.

It is understandable that a legal arrangement
built on family economic interests would be popular in
the United States where much of the country's wealth is
held in millions of family businesses. One estimate
holds that family business accounts for more than half
the gross domestic product and provides about half the
nation's jobs. Oddly enough, only three out of ten
family businesses survive into the second generation,
one in ten last to the third generation and the average
family enterprise lasts only about twenty-four years.
Many of the reasons for the demise of individual family
businesses are found in family dynamics and psychology
which overlap problems of both family and business,
either of which can be daunting on its own. Active
family partnerships often mirror all these concerns and
cease because of them.

Partnerships Defined

First we should consider some basic facts about
partnerships in general.

A "partnership" as defined by the Uniform
Partnership Act, a variation of which is applicable in
most states of the U.S., is "an association of two or
more persons to carry on as co-owners a business for
profit." A partnership requires an agreement between
two or more competent persons to place their cash,
assets, labor and skills into a business and divide the
profits and losses, usually in proportion to the degree
of each of their ownerships. A partnership is
recognized for most legal purposes including contracts,
credit, bankruptcy, incurring debt, marshalling assets,
and acquiring and transferring property but it does not
pay tax.

General Partnerships

In a "general partnership," which is usually used
for a commercial business purpose, each general partner
shares equally in management and control. Each partner
is also equally personally liable for partnership debts
(after partnership assets are exhausted) to the full
extent of their own personal wealth, this being the
greatest general partnership disadvantage. This
liability is one of the reasons that persons involved
in partnership businesses often seek asset protection.

There are distinct advantages to being a partner
in a general partnership. A general partner shares in
all profits and since partnerships are not taxed as
such, avoids the double taxation imposed on corporate
dividends (corporate income tax plus individual income
tax). A general partner can withdraw his full
contribution without taxation. Along with other
general partners he jointly manages and conducts the
business with complete access to all books and
financial information and can obtain joint credit with
other partners.

As noted, each partner can be held personally
liable for all partnership debts, even those which
result from one partner's negligent or harmful acts.
General partnerships often must be dissolved when one
partner files personal bankruptcy or dies unless quick
arrangements are made for a buy out of that partner's
interest or unless the partnership agreement allows for
such events. Usually a deceased's partner's
partnership interest must go through probate. Even
though a partnership is not a taxable entity it must
file an annual tax return and when one party dies his
interest is subject to estate and inheritance taxes.

General partnerships are often faced with the
personal problems inherent in any joint ownership
arrangement resulting from divorces, inheritance by
non-members who may be undesirable as partners or the
sudden death of a partner. As you can see from this
discussion, general partnerships do not serve any
really useful role in personal asset protection.

Limited Partnerships

Limited partnerships have been recognized in
Anglo-American common law and in civil law for
centuries. In a U.S. limited partnership the Uniform
Limited Partnership Act requires there be one managing
"general partner" (not to be confused with members of a
general partnership as just described) who is solely
responsible for management and control of the business.
The limited partners must refrain from taking part in
management lest in the eyes of the law they lose their
limited status and its considerable benefits. The
virtue of a limited partnership lies in the fact that
limited partners are not individually liable for
partnership debts beyond the property interest they
contribute to the partnership.

Another advantage of a limited partnership is that
a personal creditor of a limited partner cannot attach
that partner's interest in the partnership. A creditor
can only obtain what is known as a "charging order," a
relatively unattractive remedy in the judgment
collection process usually requiring the creditor to
wait for the future distribution of partnership income,
a totally discretionary act resting with the managing
partner.

The courts of the State of California, which has
one of the most liberal partnership laws, have recently
called into question the near creditor-proof status of
a limited partner and his partnership assets. In two
cases these courts have held that under certain
circumstances a debtor's partnership interest can be
foreclosed to honor a judgment, a major departure from
past holdings and a significant loss of asset
protection. These decisions undermine the use of the
family limited partnership for asset protection
purposes, although many promoters sell family limited
partnership packages which they claim are completely
full proof asset protection devices.

"Family Partnerships"

The arrangement known as a "family partnership" is
created as a means to transfer income and assets from
the organizer or owner of a business or one who has
accumulated assets of value to members of his or her
family in a manner which limits personal and tax
liability. It is nothing more than a regular limited
partnership in which family members rather than non-
family business associates are the partners. This
arrangement comes with all the intra-family problems we
noted as well as the advantages of close relationships.

Under the law in most states there is a
requirement that a formal "articles of limited
partnership" be signed and publicly registered with the
state as notice of the business scope and the limits of
partners' liability. These documents are technical,
requiring legal and tax advice in order to insure both
the partners' maximum advantage and that the agreement
is valid.

The California cases cited may also have a future
effect on the recent popularity of family partnerships
as asset protection vehicles. The principal reason for
laws providing partnership interest protection has been
to prevent the creditors of one limited partner from
disrupting partnership business continuity and harming
the other partners by a foreclosure. If the only
business of the partnership is the holding of family
assets, including a personal residence, it may be
difficult to argue that the family partnership has any
real business in a commercial sense which will be
disrupted by the foreclosure or that the business of
innocent, non-related third parties will be prejudiced.

Family limited partnerships have been under legal
siege in other important respects as well.

The U.S. Internal Revenue Service, in a series of
court cases, some appealed to the U.S. Supreme Court,
has often successfully challenged the validity of both
limited and family partnerships. In so doing the
courts have imposed a series of tests which must be met
in order to create a valid family (or any) limited
partnership. In these tests the courts inquire into
whether each partner (especially if a minor) has true
title to and control of his or her interest; regardless
of statements in the partnership articles, what is the
true intent and relationship of the parties; what
actual capital and/or skill does each partner
contribute; and does each limited partner really
control the income paid to him and its disposition?

These tests mean a family partnership, like any
limited partnership, must have partners who actually
perform important work on a continuing basis and who
really contribute capital or assets of some tangible
kind. The law does allow a limited partner to receive
his or her partnership interest as a gift but if the
recipient is a minor, someone other than the donor must
serve as legal custodian of that interest until he or
she reaches majority, 18-years-old in most states. A
limited partner may also purchase his or her
partnership interest with payment out of future
profits. But there are restrictions on gift and
purchased limited partnership interests, and most
courts carefully scrutinize whether the donor actually
relinquishes control and ownership of the interest and
gives it over to the donee or purchaser.

As compared to a general partnership, if it is
properly created and managed, a limited partnership can
be a valid asset protection arrangement in some
circumstances. Although a partnership is usually
thought of as operating a commercial business
enterprise it can also be used to control personal
assets such as a home or other real estate, personal
property and intangibles such as stocks, bonds and even
insurance.

If a large amount of money is involved it is
better to create more than one limited partnership, one
of which holds liquid assets such as cash, securities,
bonds, certificates of deposit, precious metals, life
insurance policies and negotiable instruments. The
other could include assets such as real estate and
business assets which might be more vulnerable to
creditor attack.

The managing general partner retains control over
all the limited partnership assets and the limited
partners who may be family members cannot and must not
assert any power in management. With the caveat
expressed above concerning new court holdings, family
partnership assets are generally safe from personal
creditors of the limited partners and in turn the
limited partnership's creditors can only attack a
limited partner to the extent of that partner's actual
investment and then only with extreme difficulty and
usually little result. For example, a partnership can
accumulate assets but cannot be compelled to distribute
them to partners thus protecting both the assets and
the partner from a creditor's charging order.

If a parent serves as a managing general partner
with a small ownership interest (say 5%) and his
children or spouse serve as limited partners with most
of the ownership divided among them (95%), when the
managing partner/parent dies, inheritance and estate
taxes are limited to the deceased's actual partnership
interest which can be a considerable saving for the
heirs/limited partners. There is no bar to managing
partner contributing the majority of the limited
partnership's assets and receiving only a small
percentage ownership interest which gives his creditors
little to pursue. Similarly when income is distributed
in a limited partnership it does not have to be in
proportion to a partner's investment or degree of
ownership; it can be in any proportion and family
members can be given a disproportionately large share.
Whatever the income distribution may be, each partner
is liable for U.S. income taxes as ordinary income.

Keep in mind also that any legal entity can be a
general or limited partner, a domestic or foreign
trust, a corporation, estate, custodian of a minor or
an association. This means that a managing general
partner in a limited partnership can incorporate for
that management purpose, further providing protection
for his corporate self from creditors and possibly
higher taxes. The corporate general partner might have
a fraction of a percent of ownership interest, but
provides another layer of insulation from suits for
acts of the partnership.

From the foregoing you can properly conclude that
a family limited partnership has the potential of being
an excellent vehicle for sheltering both personal and
family assets from creditors and for reducing estate
and inheritance taxes. But these partnerships come at
a price. Unless carefully crafted by expensive legal
experts, American courts are far too eager to use legal
loopholes to overturn an alleged "partnership." Even
more important than the legal crafting of the initial
documents is the importance that the day-to-day
partnership operations conform precisely to the legal
requirements. Substance is at least as important as
form, a detail that many family partnership package
promoters and their clients overlook. After the fact a
family may find itself in a situation worse than if
nothing been done.

While there is a certain flexibility in a family
partnership for the managing general partner, the donor
still must deed absolutely his assets to the
partnership and normally all partners must agree before
partnership assets can be sold or transferred. As with
any partnership, unless the partnership agreement and
relevant state statutes specifically provide otherwise,
one partner's death or bankruptcy may force the
dissolution of the partnership (or a forced buy out) at
an inopportune time for the sale and distribution of
assets. Remember partnership assets are taxed fully as
part of a deceased partner's estate. Undistributed
income may place a partner in a significantly higher
personal income tax bracket at an unexpected time,
since partners are taxed on their share whether or not
the income is distributed.

The value of a family partnership, like any
investment comes from good management and wise
decisions. Forming a family partnership does not
guarantee income or benefits, nor even asset
protection. Ultimately any value for you or your heirs
will rest not only on a particular legal device but on
the strength of the national currency in which its
benefits are paid.

One of the best strategies has been to use a
Delaware family limited partnership to hold intangible
assets (such as mutual funds, stock brokerage accounts,
and precious metals). Delaware has a well regarded
business law system that protects assets, and this also
keeps the assets out of the owner's home state. The
leading experts in creating Delaware family limited
partnerships are Asset Protection Corporation, Suite
201A, 14418 Old Mill Road, Upper Marlboro MD 20772.