California Family Limited Partnerships
California does not limit creditors to a charging order as their sole remedy. States such as Wyoming, Delaware, Florida and Nevada do. Many of the states which do not limit a creditor to a charging order such as California, allow for judicial foreclosure of a charging order. This means that a judgment creditor may sell his interest. After being sold, the debtor/general partner may still owe a significant portion of his or her debt to the creditor and to purchase the interest sold by the creditor, may have to pay more than it was sold for. The purchaser of the interest will also have the right the creditor had to distributions, and possibly until the partnership is dissolved. A creditor who forecloses on a charging order will still have a difficult time selling it, even to a collection agency, which may incur adverse tax consequences. The debtor will still not have lost his or her management or voting rights. An assignment of a limited partnership does not dissolve the family limited partnership. Additionally, there's nothing to prevent a partner from putting language into the operating agreement a restriction against the assignment of a limited partner's interests. Another way to maximize the utility of a charging order is to provide in the operating agreement that when distributions are made, the debtor vests in the distribution while at the same time instructing the general partner to withhold any distributions to limited partners against whom there are charging orders. This will conceivably allow the Family limited partnership to charge the creditor with income without ever having to make a distribution to the creditor who has foreclosed on a charging order. Poison pills may also be inserted into the family limited partnership operating agreement with provisions allowing the Family limited partnership or non-debtor partners to buy out a debtor for a negligible amount of money, thereby leaving the creditor with only this small amount of money the creditor can collect, and to treat a judgment creditor as the owner of that portion of a partnership interest for income tax purposes without the ability to replace the general partner, require distributions or force a liquidation of the family limited partnership. A family limited partnership agreement can also include buy-out provisions and rights of first refusal that provide for the right of other partners to buy out a partner's interests to prevent unwanted persons, including ex-spouses from becoming partners. With income passing through to and being taxed at the income tax rates of the limited partners, income can be shifted from the parents to the children who in most cases may have lower tax rates. Children under the age of 14, however, who receive income are taxed at their parent's tax rate. The operating agreement of a family limited partnership is the defining document of a Family limited partnership and there is little that it may not affect in the operation of the Family limited partnership. Properly drafted to deal with circumstances that may arise, the operating agreement should be carefully drafted with such foreseeable situations in mind. However, if an individual is concerned that any future creditor will be able to foreclose on a charging order the creditor obtains in California, the individual can form the Family limited partnership in a state that does not allow foreclosure of charging orders, such as Wyoming or Nevada, and then quality the Family limited partnership to do business in California by paying the appropriate fee and filing the appropriate form with the Secretary of State. Family limited partnerships are neither foolproof nor bullet proof. Any assets located in or subject to the U.S. legal system are exposed to well-crafted legal arguments and attack by attorneys for well-heeled creditors. In California, a transfer by an individual is not safe under the statute of limitations from a fraudulent transfer lawsuit until seven years have passed from the date of the transfer. In addition any debtor who removes property out of the state or fraudulently sells, assigns or conceals his or her property with the intent to defraud, hinder or delay his or her creditors is punishable by imprisonment in jail not exceeding one year or by a fine of one thousand dollars or by both. Family limited partnerships should be looked at as a deterrent to creditors, not as a force field that can't be broken. Just as in Star Trek, the Enterprise's force field was always losing strength if not shutting down altogether, a family limited partnership's protection can also break down. Even if no creditor claims exist prior to the transfer of assets to a family limited partnership, a risky asset held by the family limited partnership may generate liability and cause the partnership assets to be at risk by a litigant. A general partner of the Family limited partnership may also find himself or herself personally liable if for instance, he or she personally guaranteed repayment to a creditor. If a family limited partnership is properly drafted, is created for the right reasons and assets are transferred to it well before any creditor's claims exist, although their cost is substantial, a family limited partnership can limit one's exposure to creditors, reduce or eliminate some creditor remedies and even provide tax savings. However, their protection is not absolute and they are not by any means a miracle in a bottle. In compliance with IRS requirements, we must advise you that any U.S. federal tax advice or family limited partnership contained in this informational article is not intended to be used nor is it published in order for it to be used and you may not use it for the purpose of avoiding penalties or fines under the Internal Revenue Code or under California law. It is not intended to be used nor is it being published in order to promote, market or recommend any specific transaction, tax-related matter or estate planning tax scheme to any party.