Does the Medical Professional exist who doesn’t fear a malpractice lawsuit? Doesn’t the possibility of a court judgment of several million dollars at least occasionally enter your thoughts – perhaps before you go to sleep at night, when you have your hands in a patient’s mouth, or when you’re just relaxing with your family? Does the apprehension sometimes keep you from truly enjoying your profession?
You probably spend a great deal of time determining how to market to potential patients, how to keep patients, how to provide the best technical care and how to keep operating costs down. The tragic irony though is that even after all your efforts in these areas-regardless of their degree of success-as a health professional, you’re still at high risk for malpractice, discrimination, wrongful termination, and harassment claims, among others. (One grandmother who loaned her grandson $2,000 was hit with a $1.5 million court judgment after he was cited for negligence in a collision – with no liability insurance. The jury held her culpable for not knowing more about her grandson’s driving ability, even though she’d never ridden with him.) A litigious mentality is, unfortunately, an inescapable state of American society.
Are there effective ways of protecting yourself? Yes, but you must think ahead. Waiting until you’ve been slapped with a suit won’t help. One of the best ways to cover yourself before you receive notice that you’re a defendant is the Family Limited Partnership (FLP). As partners in a 30-year old estate planning firm, we recommend it to nearly every Medical Professional who is at the slightest risk for malpractice or simply has assets to risk. (That’s just about everyone nowadays.)
The Family Limited Partnership (FLP) is a central tool and first line of defense for safeguarding your assets not only against legal judgments, but also other creditors and taxes. Establish an FLP in the right state, and you’ll have a powerful asset protection tool. Limited partnerships have been around since the turn of the twentieth century, but in the last several decades, attorneys have increasingly used the Family Limited Partnership to protect their clients’ wealth and gain tax efficiency. This tool may be used effectively in conjunction with a revocable living trust, which may be the general partner of the FLP.
How the Family Limited Partnership Works
Imagine that you and your spouse own stocks, bonds, mutual funds, and other assets and that you create a Family Limited Partnership. The FLP consists of the two of you as, for instance, a 2 percent general partner (GP). The GP is the partner responsible for managing the partnership and is personally liable for partnership (not personal) debts. Both of you also receive the remaining 98 percent of the partnership as limited partners (LPs). LPs are exempt from the debts and liabilities of the partnership. You and your spouse may then give small LP interests to your children or others, for example, one or two percent each. The more partners, the stronger the FLP for both tax benefits and asset protection.
FLPs as Protection Against Creditors
The unique aspect of a limited partnership, which makes it such a potent asset protector, is that laws in virtually every state provide that “a creditor cannot reach the assets of a partnership to satisfy the personal debts of a partner.” These laws exist to protect other partners from the liabilities of one partner. In other words, if you’re hit with a lawsuit, you may count on a high degree of protection for all those assets “owned” by the FLP.
In a coordinated plan with a properly structured FLP holding, most – if not all – of your liquid wealth and other assets are secured. A would-be plaintiff or plaintiff’s lawyer will have second thoughts about initiating a lawsuit against you, the judgment of which may be extremely difficult to collect. In our practice, we’ve often experienced the magical disappearance of a plaintiff’s lawyer upon discovering our clients have FLP protection.
This isn’t to say a judgment creditor has no remedy with regard to an FLP. They do. It’s called a “Charging Order”, and we’ll discuss it later in this article.
It’s wise to understand how the asset protection value of the FLP in an overall estate plan can be used most effectively. It’s also important to draw upon the skill and experience of a professional advisor in this field.
What to Remember in Setting up an FLP
The first consideration in creating an FLP is jurisdiction. The laws of the state where the FLP is registered are critical. Because you, the client, have a choice of jurisdiction, you want to select a state with very clear statutes and case law governing the charging order. We register the FLP in a non-resident state (one in which you’ve not established a residence) to further enhance the privacy aspects and because it’s just more difficult to pursue a claim there.
The second important consideration is deciding which assets to transfer to–and which to leave out of–your FLP. For maximum benefit, we prefer the “primary” FLP to own only “safe assets” (items that in themselves possess no inherent liability. For instance, you can’t injure someone with a stock certificate.) Do transfer cash, stocks, bonds, mutual funds, notes receivable, accounts receivable, stamp and coin collections, art objects, etc. Life insurance policies may also be owned by your FLP, but analyze your insurance separately in order to look at several key issues in ownership. Do not transfer your personal residence, rental real estate, raw land, or an active business (unless the business is in a limited liability company (LLC).
Generally, risky assets such as those described above, as well as autos, boats, airplanes, and motor homes, should not be mixed with safe assets in your primary FLP. To maximize your protection, some of these risky assets might best be placed in a LLC. Other items not to be placed in an FLP are tax-deferred annuities (they would lose their tax deferment), S-Corp stock (tax law prohibits it), and all varieties of retirement plans, including IRAs and KEOGHs (the law requires the individual to own these personally).
Can FLPs Reduce Your Taxes?
Who wouldn’t like to reduce their taxes? The FLP has the ability to reduce or even eliminate federal estate taxes. It’s an ideal vehicle for reducing your gross taxable estate. As an individual, you can pass $5.43 million to your heirs tax free (2015 amount) and a husband and wife can pass double this, $10.86 million as their lifetime gift/estate tax exclusion. Everything above that amount is exposed to an estate or gift tax that can rises to 40 percent. If you have estate tax concerns, congratulations! and then the FLP becomes even more powerful in reducing estate taxes through gifting limited partnership interests to your children (using part or all of the lifetime exclusion and the annual $14,000 per person gift exclusion), the two of you as general partners can dramatically reduce your gross taxable estate. You needn’t be concerned about losing your decision-making power. Parents as general partners control the FLP. It’s therefore not a difficult decision to gift ownership to children, since you retain control.
Yet the law makes it even more attractive: imagine you’ve set up an FLP comprised of $14 million of your gross taxable estate. You have the FLP professionally appraised at a 35 percent valuation reduction (for lack of marketability and being a minority no-management share) valuing the FLP at only $9.1 million for estate and gift tax purposes. This reduction may translate into over $1 million of taxes saved and passed on to your heirs instead of the IRS. Attorneys and CPAs familiar with this process can structure even very large estates to have no estate tax liability. Valuation discounts vary and can be determined by a qualified CPA.
Family Trust Setup and Administration
The cost of setting up an FLP is small, considering its great benefits – especially if you find yourself the unfortunate victim of litigation. The cost of properly setting up an FLP typically ranges from $4,000 to $6,000. You’ll be required to file an annual partnership form 1065 tax return and K-1s to each partner. If your return is not too complex (because it holds mostly liquid assets), your accountant’s annual costs will be modest.
Remember that the power of the charging order is important in the selection of the jurisdiction of the FLP. The charging order serves as a kind of lien against the debtor partner’s interest. We choose only states specifying that the charging order is the exclusive remedy available to a creditor. In this situation, the charging order is often a cure worse than the disease because the judgment creditor becomes responsible to pay all taxes due on the partnership interest–even if there is no distribution to the debtor partner. This has discouraged many a judgment creditor from using the charging order.
Fraudulent Transference of Assets
Beware! Assets transferred to an FLP must not be fraudulently conveyed or transferred. If after having been put on notice of a claim against you, you attempt to put assets into an FLP, it won’t work. Not only will your assets be unprotected, but you may be forced to reverse the transaction. Fraudulent transfer occurs when you convey assets with an actual intent to hinder, delay, or defraud a creditor. If you properly set up your estate plan in advance, however, fraudulent transfer is not an issue. Don’t plan on your lawyer’s expertise to compensate for your lack of foresightedness. The codes of professional conduct for lawyers prohibit counseling in fraudulent activity.
In the area of estate, business, and asset protection planning, there’s no substitute for taking action NOW. The attorneys at Lodmell & Lodmell will be glad to answer your questions and may be reached at 800.231.7112.
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