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.