When properly constructed, a Family Limited Partnership boasts a pretty impressive array of legal protection for the participants. There are a few twists and turns to the following scenario, so pay close attention. This could save your financial neck down the road.

For starters, a family partnership is simply a variation on a general partnership or limited partnership. It’s an artificial business entity created to hold a family’s liquid assets like stocks, cash, CD’s, and mutual funds. Just for fun, let’s pretend you start one with your spouse and stock it with $500,000 worth of assets. The agreement states that your spouse acts as general partner with a 2% share size. You own the remaining 98% as a limited partner. A normal arrangement would have the partner with the higher likelihood of being sued with the larger percentage of ownership.

Now let’s create an interesting scenario. Assume you (the 98% shareholder) are sued by a creditor who manages to obtain a $50,000 judgment against you. While the creditor can attach your limited partnership interest, he or she can only lay their hands on income as it is distributed to you. The problem for them is that the general partner (your spouse) has sole discretion over how income is distributed, if it is to be at all. The GP might just as well decide to reinvest all profit and not pay out anything.

See how that works? The general partner can choose to simply stop paying distributions and there’s nothing a creditor can do about it. And now it gets even more interesting. Fast forward a year. There the creditor sits with an uncollected $50,000 judgment and no way to force payment. Now the partnership turns around and sends a “K-1” statement to the creditor for his or her share of the “phantom” income. Assuming a 10% annual return, a creditor with an interest attached to a Family Limited Partnership might easily get stuck with a tax bill for thousands of dollars!

And if the creditor decides to attack the general partnership interest, you can simply buy your spouse out for the 2% and find another general partner. Any way you slice it, this particular business entity offers a near invincible level of asset protection.

The AIPIS Team

Flickr / ronnie44052