Proper planning and training of the FLP is critical, but there are certain events that must be avoided or you risk invalidating the FLP. If the person or persons transferring assets to an FLP are terminally ill, the IRS may invalidate the FLP as it is seen as a way for the transferor to hide the assets rather than protect them.
It is equally important not to transfer all of one’s assets to an FLP. A person must maintain sufficient funds to handle daily expenses. Failure to do this could cause adverse tax effects. Additionally, FLP assets cannot be used to pay for personal expenses without following FLP’s terms. Of course, this refers to distributions from the FLP to the owner. An owner cannot just take money every time he decides to do so. There are specific circumstances in which distributions can be made and should be listed in the FLP agreement.
The FLP should not make excessive distributions to a homeowner to pay for living expenses. After the death of the owner, the FLP does not have to pay inheritance expenses or inheritance taxes. That must be handled with the owner’s personal funds or through a life insurance policy. Distributions to certain partners and not others can spell tragedy for an FLP.
An FLP is a legal business entity and should be treated as such. The correct transfer of assets must be handled legally. If a home is being transferred, then a real estate deed must be drawn up and filed with the appropriate government entity. The same is true for a vehicle. Title and registration must be transferred through the Department of Motor Vehicles. Any other property that has title must be transferred in the same way. Other assets can be transferred through the use of a bill of sale indicating the date, the name of the transferor and what was transferred. A nominal purchase price must be established. In addition, the FLP must maintain proper books and records, as any business would. If there are no changes to the FLP’s investment or business strategies, the IRS may question the validity of the business.
Without active participation of the youngest members of the family
When some of the limited partners are not actively involved in business decisions and are unaware of the operations, then the FLP may be in jeopardy. All family members should be able to obtain the advice of an independent attorney or hire an appraisal expert; otherwise, the IRS may not allow the tax benefits.