Proper FLP planning and establishment is essential, but there are certain events that must be avoided or you risk canceling the FLP. If the person or persons transferring assets to the FLP are in a critically ill situation, the IRS may cancel the FLP because it is seen as a way for the transferring party to hide assets rather than protect them.
It is equally important not to transfer all of one’s assets into the FLP. One has to maintain sufficient funds to handle daily expenses. Failure to do this can have an adverse tax effect. Also, one cannot use FLP assets to pay for personal expenses without following the terms of the FLP. This of course refers to the distribution from the FLP to the owners. An owner can’t just take the money whenever he decides to do so. There are special circumstances under which distributions may be made and must be specified in the FLP agreement.
The FLP must not make excessive distributions to owners to pay for living expenses. Upon the death of the owner, the FLP may not pay property fees or property taxes. It must be handled from the owner’s personal funds or through a life insurance policy. Distribution to certain partners and not to others can spell tragedy for FLPs.
FLPs are legal business entities and should be treated as such. Proper transfer of assets must be handled legally. If a house is relocated, a real estate deed must be drawn up and filed with the proper government entity. The same goes for vehicles. Title and registration must be transferred through the Department of Motor Vehicles. Other assets with proprietary rights must be transferred in the same way. Other assets can be transferred using a sales memorandum stating the date, the name of the transferor and the person transferred. A nominal purchase price must be made. Additionally, FLPs must keep proper books and records as any business would. If there is no change in the FLP’s investment or business strategy, the IRS may question the validity of the business.
No Active Involvement by Younger Family Members
When one of the limited partners is not actively involved in business decisions and is unaware of its operations, then the FLP may be in jeopardy. All family members should be allowed to seek advice from independent counsel or retain expert judgment; otherwise, the IRS may not allow tax benefits.
