Start Your Own Corporation. Garrett Sutton

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      In the scenario on the left, with Joe Dokes as an individual general partner, he is personally responsible for all activities of Dokes, LP. All his personal assets are at risk. In the scenario on the right, Dokes, Inc. carries all of the liability. Joe’s personal assets are not exposed.

      As such, many, if not most, limited partnerships are organized using corporations or LLCs as general partners. In this way, both the limited and general partners achieve limited liability protection.

      RETAINED MANAGEMENT

      Because by definition limited partners may not participate in management, the general partner maintains complete control. In many cases, the general partner will hold only 2 percent of the partnership interest but will be able to assert 100 percent control over the partnership. This feature is valuable in estate planning situations where a parent is gifting or has gifted limited partnership interests to his children. Until such family members are old enough or trusted enough to act responsibly, the senior family members may continue to manage the LP even though only a very small general partnership interest is retained.

      RESTRICTIONS ON TRANSFER

      The ability to restrict the transfer of limited or general partnership interests to outside persons is a valuable feature of the limited partnership. Through a written limited partnership agreement, rights of first refusal, prohibited transfers, and conditions to permitted transfers are instituted to restrict the free transferability of partnership interests. It should be noted that LLCs can also afford beneficial restrictions on transfer. These restrictions are crucial for achieving the creditor protection and estate and gift tax advantages afforded by limited partnerships.

      PROTECTION FROM CREDITORS

      Creditors of a partnership can only reach the partnership assets and the assets of the general partner, which is limited by using a corporate general partner which does not hold a lot of assets. Thus if, for example, you and your family owned three separate apartment buildings, it may be prudent to compartmentalize these assets into three separate limited partnerships, using one corporate general partner whose sole purpose is to manage all three LPs. If a litigious tenant sued over conditions at one of the properties, the other two buildings would not be exposed to satisfy any claims. This is an attack brought directly against the property, and will be discussed further in Chapter 5.

      There is a second attack to be concerned with: One against not the LP itself but against the owner of the LP (or LLC).

      Creditors of the individual partners can only reach that person’s partnership interest and not the partnership assets themselves. Assume you’ve gifted a 25 percent limited partnership interest in one of the apartment building partnerships to your son. He is young and forgets to obtain automobile insurance. Of course, in this example, he gets in a car accident and has a judgment creditor (a person who sued and won) looking for assets. This creditor cannot reach the apartment building asset itself because it is in the limited partnership. He can only reach the limited partnership distribution interest through a charging order procedure. A charging order allows the creditor of a judgment debtor who is in a partnership with others to only reach the debtor’s partnership distributions without dissolving the partnership. Charging orders are not favored by creditors because it forces them to wait to be paid. (Lawyers who take on contingency cases do not like to wait for payment, either.)

      The state laws of Nevada and Wyoming offer the best charging order protections. California offers the weakest protection. A strategy then is to form your LP (or LLC) in Nevada or Wyoming and then qualify in California. (Qualifying is the process of registering your out-of-state entity to do business in your home state and includes paying the same annual fees as if you have started the entity in your home state to begin with.) An even better strategy is to form several LLCs in California and have them be owned by one Wyoming or Nevada LLC. By using a Nevada or Wyoming LLC or LP to hold your Home State LLCs you can obtain the benefit of a better asset protection law. This strategy is discussed further in Chapter 4.

      FAMILY WEALTH TRANSFERS

      With proper planning, transfers of family assets from one generation to the next can occur at discounted rates. As a general rule, the IRS allows one individual to give another individual a gift of $13,000 per year (at this writing).

      Any gifts valued at over $13,000 are subject to a gift tax starting at 18 percent. In the estate planning arena, senior family members may be advised to give assets away during their lifetimes so that estate taxes of up to 55 percent are minimized.

      By using a limited partnership for the management and gifting of family assets, gifting can be accelerated with an IRS-approved discount. As discussed, because limited partnership interests do not entitle the holder to take part in management affairs and are frequently restricted as to their transferability, discounts on their value are permissible. In other words, even if the book value of 10 percent of a certain limited partnership is $16,000, a normal investor wouldn’t pay that much for it because, as a limited partner, they would have no say in the partnership’s management and would be restricted in their ability to transfer their interest at a later date. So, instead of valuing that limited partnership interest at $16,000, the IRS recognizes that it may be worth more like $13,000.

      The advantage of this recognition comes into play when parents are ready to gift to their children. Assume a husband and wife have four children. Each spouse can gift $13,000 per year (at this writing) to each child without paying a gift tax. As such, a total of $104,000 can be gifted each year (two parents times four children times $13,000). With the valuation discount reflecting that the $16,000 interest is really only worth $13,000 to a normal investor, each parent gifts a 10 percent limited partnership interest to each child. Their combined gifts total an $104,000 valuation, thus incurring no gift tax. However, of the partnership valued at $160,000 they have gifted away 80 percent of the limited partnership with a book value of $128,000. Had they not used a limited partnership they would have had to pay a gift tax on the $24,000 difference between the $104,000 discounted gifted value and the $128,000 undiscounted value of eight $16,000 10 percent partnership interests that were gifted. (I know this may seem complicated. Please do not worry—it is complicated. Feel free to come back to it later, or not at all.)

      The key point to remember is that transfers of family wealth can be accelerated through the use of limited partnership discounts. Once this technique is appreciated, the question always becomes: How much of a discount will the IRS allow? Is it 25 percent, 35 percent, or can you go as high as 65 percent? While there is no bright-line test or number, the simple answer is found in this maxim: Pigs get fat, hogs get slaughtered. If you get greedy with your discounting, the IRS will call into question all of your planning. In my practice I do not advise my clients to go over a 33 percent discount.

      The IRS has been questioning cases where the discounts are above that percentage. That said, the 33 percent limit may be conservative. I have dealt with some professionals who with certainty assert that higher discounts are easily justified. Again, there is no correct answer. You and your advisor should establish your own comfort level.

      FLEXIBILITY

      The limited partnership provides a great deal of flexibility. A written partnership agreement can be drafted to tailor the business and family planning requirements of any situation. And there are very few statutory requirements that cannot be changed or eliminated through a well-drafted partnership agreement.

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