Asset protection can come in several forms. First, Texas law provides for the protection of some of your assets by statute, such as the homestead exemption that protects your home from the claims of most of your general creditors. Additionally, the law provides creditor protection for many types of retirement plans, including qualified plans (401(k), etc.) and Individual Retirement Accounts (IRAs), as well as some forms of life insurance plans. The type of protection provided by law is automatic and generally requires no affirmative action on your part to assert these rights. There are, of course, exceptions to the protection provided under the law, and it is important that you understand these exceptions and your rights under Texas and federal law.
In addition to the protection provided as discussed above, there are certain other asset protection strategies that may make sense in certain situations. One of the simplest involves the ownership o a business. For instance, if you are operating your business as a sole proprietorship rather than as a corporation, limited liability company (LLC), or other entity, you may be putting your personal assets at risk if the creditors of your business sue you. This is because as a sole proprietor, there is generally no distinction between you individually and the business you operate, so if a creditor sues your business, it is essentially the same as suing you individually, which puts not only your business but your personal assets at risk. By forming some form of corporate entity, such as an LLC, you may be able to insulate your personal assets from creditors of the business, providing you with a layer of protection for your personal assets.
For individuals or families who have substantial assets, a popular form of asset protection is to form a family limited partnership (FLP).
In 2009, Husband and Wife form the FLP by each acquiring a small percentage interest as general partners of the partnership, and at the same time they acquire all of the limited partnership interests in the partnership. They then transfer some (often a substantial amount) of their assets to the partnership. Popular choices for assets to transfer to the FLP include liquid assets, such as stock portfolios, but can include other assets such as real estate and interests in other closely held businesses.
Beginning in 2009, Husband and Wife will give away shares annually of their limited partnership interest to their descendants (i.e., children and grandchildren).
The benefits of an FLP are due primarily to the fact that limited partnership interests in a business are generally considered to be less valuable than general partnership interests in the business. As a result, the value of the limited partnership interests is generally discounted due to the lack of marketability and lack of control associated with the partnership interests.
Example: Husband and Wife transfer two pieces of rental real estate with a total value of $2.5 million $3 million of their stocks to the FLP. Subsequently, they give each of their children (via a gift) 1% of their limited partnership interest. An appraisal of the 1% limited partnership interests shows that the interests have a value of $33,000.00, which is the value of the gift that must be reported to the IRS. Why is this value less than $55,000 (1% of $5.5 million)? The answer in part is that the lower value results from the fact that the limited partnership interests are less valuable than general partner interests because the general partner controls the operations of the business. Due to this discount, Husband and Wife can give away larger amounts of their estate at any one time by giving away the partnership interests that are valued at a discount.
The Internal Revenue Service is well aware of the use of FLPs in the context of estate planning, and as a result has closely scrutinized these partnerships to determine, among other things, whether the partnership has a legitimate business purpose. Additionally, there is the potential that future law will remove the ability to apply the valuation discounts for gift and estate tax purposes, which would somewhat reduce the usefulness of the FLP as an estate planning tool. Consequently, the decision to create an FLP should be very carefully considered and only with the advice of an attorney.
If properly planned and implemented, an FLP can be a highly effective and useful tool in an overall estate plan. However, the creation of an FLP can pose significant risk for people who do not receive proper legal advice regarding the formation and operation of the FLP. There are several factors that go into the planning and creation of an FLP, including estate planning considerations, tax considerations, and business organization considerations. Before deciding to form an FLP, it is important to seek the advice of an attorney who can help you determine how an FLP might fit your overall business and estate planning needs.