"My brother never told the family that he was in financial trouble." Our client, the executor of her mother's estate, sold her mother's property and reluctantly paid her brother's share of the estate to his creditors. With some open discussion in the family and a small amount of planning, this result could have been avoided. The inheritance could have been saved to provide education and security to another generation.
The first two articles in this series were written by my colleagues, Gary Orlando and Bill Rohrbach, and focused on the use of legal entities such as corporations and limited liability companies to shield assets from creditor claims. This article focuses on planning over several generations. Asset protection and estate planning are partners in the sense that the goals of both can be accomplished with the same effort. The keys to multi-generational asset protection are: (1) start early, before there is a problem; (2) avoid outright gifts; (3) use an asset protection entity such as a discretionary trust or a family limited partnership; and (4) where necessary, make use of disclaimers.
Discretionary Trust. The discretionary trust is a powerful asset protection tool. Our clients choose such a trust where there is a concern that family money or property will pass to someone who has a high degree of risk. The protection is so strong that even the IRS has not been able to penetrate a properly drafted and administered trust. The secret of the discretionary trust is that distributions are made only when the trustee decides to make them. Therefore the trust beneficiary has no "right" to take money from the trust. The trustee can thwart a beneficiary's creditor by refusing to make any distribution at all. A protective discretionary trust can be part of a tax-planned will.
Family Limited Partnership. The family limited partnership ("FLP") is a popular estate planning tool. A limited partnership is an entity which has one or more general partners and one or more limited partners. The limited partners have no management responsibility or authority and no liability for partnership obligations beyond their investment. Limited partners have rights similar to stockholders of a corporation. In an FLP, the limited and general partners are (or are controlled by) members of one family.
A limited partner or a general partner can be a natural person, a partnership, a limited liability company, a trust, an association or a corporation. This flexibility provides opportunities for business planning, estate planning and asset protection. Thoughtfully drafted and properly managed, an FLP has many attractive features enabling families to accomplish their personal, financial and tax goals.
More flexible than a trust and easier to dissolve than a corporation, the FLP can be terminated without adverse tax consequences. It is used to consolidate assets for efficient management and to allow parents to give their children and grandchildren interests in the family assets without dissipating family wealth. Because of restrictions on transferability, the FLP offers excellent creditor and adverse spouse protection. The FLP is a "pass through" entity for federal income tax purposes and is not subject to state franchise tax. Provisions for alternative dispute resolution can provide a mechanism for settling family disputes out of court. An FLP can be used to reduce or eliminate ancillary probate and guardianship proceedings for out-of-state property. The FLP is used to formalize the operation of a family business and the management of family assets, train members of the younger generation and promote family communication.
Persons interested in lifetime giving programs designed to reduce the impact of federal gift and estate taxes may find the FLP an ideal vehicle to accomplish their goals. Parents can give children and grandchildren interests in an FLP instead of giving them the assets outright. Although the assets are the same in either case, the assets held by an FLP are subject to minority discount valuations, sometimes up to 40%. This enhances lifetime giving programs by allowing more assets to pass subject to the lifetime exemption of $600,000 and the annual gift tax exclusion of $10,000.
Creating an FLP will mean additional legal and accounting fees. Discount valuations are subject to IRS scrutiny. Were the IRS to make a valuation adjustment at audit, there would likely be additional taxes, interests and penalties. For this reason, we recommend our clients use a professional appraiser to determine the fair market value of limited partnership interests.
Tax-Planned Wills and Disclaimers. Most people with assets already know the necessity of having a tax-planned will which maximizes the use of the unified credit against estate taxes. Most people aren't aware that a beneficiary under a will can disclaim the gift. A disclaimer has the legal effect of passing property as though the original beneficiary had predeceased the person who made the will. The disclaimer must be filed with the court within nine months of the decedent's passing. If some thought is given to the possibility of a disclaimer when the will is drafted, the family will have a contingency plan in place. Then, if the original beneficiary is liable to pay claims, the beneficiary can disclaim and the inheritance will pass to one who is not liable to pay claims.
The information in this article is meant as an introduction to the discretionary trust and the FLP. Our clients often use a combination of an FLP, trusts and tax-planned wills in planning their estates. Any new entity should be evaluated as a part of an overall family business and asset maintenance and transfer plan.
Published in the Greater Houston Edition of M.D. News, April 1997
The information provided in this article is not legal advice to any reader. Neither the transmission nor the receipt of this article creates an attorney-client relationship. The opinions expressed in this article may not be those of the firm.