FLPs are complicated structures, and we want you to implement your FLPs properly. Carelessness and failure to abide by formalities may lead to a creditor undoing, or the IRS challenging, many of the benefits of an FLP. Thus, we present this reminder to clients who have established FLPs.
Keep accurate records of transactions, investments, sales of property, etc. Keep these records separately from your personal records. Keep records of distributions from the FLP to the partners. The simplest repository of a partnership’s financial records is the partnership’s bank account check register. It is often most convenient to keep all records in the FLP binder.
Do not commingle FLP assets and other assets. Do not pay for personal expenses from the FLP accounts. If a creditor wants to pierce an FLP, and he can show that you used the FLP for personal expenses, then the creditor will have an easier time convincing a court that there is little distinction between FLP assets and your personal assets, subject to attachment. Respect the integrity of the FLP as a distinct entity, and use FLP accounts only for FLP, not personal, purposes. Consider all expenses not related to the FLP or its assets as personal.
Have annual meetings. Annual meetings need not be formal in form, and can occur over brunch or at Thanksgiving dinner.
Keep minutes of the annual meeting, and any other meeting. You don’t need a lawyer to record the minutes; keep a log in plain English of what was discussed, and what was decided by the partners. The minutes can be as simple as: “All partners attended. We discussed the tax return deadline.”
Annual gifting, and proper records and valuation of gifts. If you’ve set up the FLP for estate planning purposes, then follow through with that intent, and every year, gift limited partnership interests to your family members. This is one formality where you may want to consult with an attorney, to make sure the Memorandum of Gift and the valuation calculations and statements are correct. This is an area of particular IRS scrutiny, so properly documenting your annual gifts will go a long way in the event of an audit.
Keep periodic valuations of FLP property. You will need these valuations and appraisals for tax purposes, and as backup for valuation discounts of gifted FLP interests.
Annual renewal. Be on the lookout for the renewal notices sent by the Secretary of State. Don’t let the FLP lapse because you don’t pay the annual renewal fees.
Annual tax return. FLPs must file an IRS Form 1065 each year, generally by April 15th. This is an informational return, listing the partners and their share of FLP income. FLPs must also issue Forms K-1s to all of the partners, which show the partners’ share of income; the income is then included on the individual partner’s 1040 income tax return. You should consult with your accountant on preparation of these forms.
Other points to keep in mind:
- Each FLP should have its own bank account. Use this account to pay for FLP expenses, such as annual renewals. If the FLP owns real estate, expenses associated with the real estate should be paid by this account. However, note this exception: if your personal residence is owned by an FLP, expenses which benefit you, e.g., decorating costs, heating bills, pool costs, should be paid from your personal bank account. Keep paying your mortgage and real estate taxes from your personal account, in order to personally benefit from mortgage interest and real estate personal tax deductions.
- If your child(ren) (or someone else) signed a promissory note to the partnership in return for their initial 2% interest, make sure they pay the interest on the note annually to the FLP.
- If the partnership makes a distribution, it should be made to all partners on a pro rata basis (i.e. according to each partner’s percentage interest in the FLP). Note that the FLP may pay management fees to the general partners; this is not a distribution. Also, the FLP may make a loan to any partner. This also is not a distribution. However, the loan must be properly documented by a promissory note. If the loan bears interest, the interest payments should be made each year. The loan should be repaid at maturity (or extended in writing).
- Having established the FLP for tax and asset protection benefits, adherence to these formalities may ensure that the FLP will withstand any challenges from the IRS and creditors. You spent a lot of time and money forming the FLP; now, keep it going properly in order to achieve your goals.