The Landmines of Wealth Protection

-"FLPS" - OVERRATED, IRS HATED!

By Albert Aiello, CPA, MST, Investor

Family limited partnerships (FLP's) have become all of the rage with the overstressed premise that they shield your family wealth with iron-clad impenetrable protection. So the primary reason for using FLP's is for asset protection? Right? Wrong! Promoters who sell expensive FLP kits would like you to believe this. FLP's do provide asset protection in the same way as limited liability companies (LLC's) and corporations do. They give you limited liability protecting you personally. However, the main reason to use FLP's is estate tax reduction, not asset protection. Unless your estate is substantially over the federal estate exemption amounts, you will generally not need an FLP.

Moreover, FLP's have recently become subjected to frontal attacks by the IRS with heavy litigation (and in fact a battleground) in numerous tax court cases over the validity of the FLP entity with a business purpose and valuation discounts on gifts of FLP units to younger family members in order to reduce estate taxes. As part of this frontal attack was the issuance of summonses to a law firm for all of their FLP marketing materials including the names and addresses of all their clients to whom any of these programs were sold to. This was by court order which was agreed to by the United States Court of Appeals. The law firm partners have been ordered to appear before the IRS to divulge their records, including the names of their clients. (Call that great protection and privacy?)

This is not meant to discredit FLP's or to sell you fear. Legally, they have their place. But you have to understand that FLP's are complex legal and tax entities that require the extremely careful draftsmanship by qualified, reputable professionals of pertinent documents and implementation of the proper procedures to ensure that the FLP is a valid entity with a business purpose, and for the devaluated gifting of limited partnership units to younger family members (not to be done by do-it-yourself kits). Moreover, besides FLP's, there are lesser audit-prone (perhaps superior) alternatives to reducing estate taxes, along with asset protection, such as Private Annuity Trusts

Outside of estate tax reduction, LLC-partnerships, with a very low audit profile, can protect you just as well, yet without the complexity and higher cost of an FLP.

Another drawback of FLP's is Passive Loss Limitations under Internal Revenue Code 469(c). Many of my students, using my Goldmine componentizing depreciation system, show large "paper" losses on their properties. They love to deduct such losses against their other ordinary income, such as W-2 income, business income, gains, pension income, IRA distributions, etc. They save thousands every year doing this. (Thousands they can reinvest for more income and more wealth). However, an FLP is a limited partnership and a limited partnership is subject to passive loss limitations. This means that such losses would not be currently deductible against your other income as per the above. (You therefore would lose the investment use of the tax savings and the related potential income; not a way to get wealthy.) On the other hand, an LLC-is not subject to such passive loss limits. Therefore using an LLC (along with a certain degree of management) will not interfere with your ability to offset loss deductions against your other income; plus LLC-partnerships are much less audit prone than FLP's.

Another drawback of FLP's (as well as other entities such as LLC's and corporations) is that while they protect you personally, they do not protect the net value of the assets within the entity, such as real estate. Many investors are misled to believe that if they put assets in an entity (such as an FLP), they are totally protected in an ironclad manner. The Titanic was ironclad too, but sunk; and so could an FLP! In future articles I will discuss a very effective way to protect ALL of your assets inside and outside of the entity.

The above discussion demonstrates that when you evaluate an asset protection vehicle, you must evaluate all sides - Legal; tax; estate; IRS; inside; outside; etc. and BEWARE of the misinformation of asset protection promoters on the circuit!