Alaska Family Limited Partnerships and Limited Liability Companies
Reasons to Use FLPs and FLLCs for Estate Planning:
- Better Management. Often an older generation will organize a variety of assets in an FLP or FLLC. These assets may include real estate, partnership interests, and security investments. Organizing these assets in one business entity, which has a designated manager in the form of general partner or manager, often allows for increased management efficiency.
- Retention of Control.Often an older generation will form an FLP or FLLC and then gift fractional interests, in the form of percentage partnership or FLLC interests, to children and grandchildren. The older generation can retain control of the management and investment of the entity's properties by being the general partners or managing members of the entity.
- Valuation Discount. When FLP or FLLC interests are transferred by gift or at death, appraisers generally conclude that the value of the assets should be significantly discounted. Depending on the entity, state law, and the type of assets held, these appraised discounts may be in the 25% - 60% range. This reduction in value is called "valuation discount," and generally produces significant transfer tax savings.
- Creditor Protection. Under state law, a creditor of a partner in an FLP or member in an FLLC is generally limited to obtaining a "charging order" against the partner's or member's interest in the entity. A creditor is not allowed to reach the assets in the entity, or ownership of the partnership or the FLLC interest itself. The creditor must wait until distributions are made to the partner or member, and at that point the creditor may reach such distributions. Often, the decision-making power concerning whether to make such distributions is in another person: the general partner or manager of the entity. Thus, an FLP or FLLC interest is often not a productive asset for a creditor to pursue.
Alaska Law Changes to Support Valuation Discount. A number of states have changed their limited partnership and limited liability company laws so as to provide the best support for the position that when these interests are transferred they qualify for valuation discount. The default rules in Alaska are that these entities have a perpetual existence, which can only be terminated by the agreement of all partners or members. Dissolution of the entity cannot be forced by the actions of a single partner or member. When Alaska amended its limited partnership law to accomplish these tax goals, it also enacted similar amendments to its limited liability company law. Therefore, the default rules for both types of entities provide strong arguments in support of valuation discount of their interests.
Creditor Protection. Alaska limited partnerships and limited liability companies perhaps provide the strongest creditor protection of any existing state law. Judicial dissolution of such entities can only occur if it is "impossible" to continue the entity's business activities. In addition, the Alaska 2000 legislature enacted amendments that clarified that a charging order is the sole remedy for creditors of partners and LLC members. To understand this amendment, the following background is necessary. Generally, limited partnership and limited liability company statutes do not expressly permit creditor remedies other than a charging order . This is consistent with the concept that the other partners of a partnership or members of a limited liability company should not have their business or investment activity disrupted by being forced to take in a substitute partner or member (e.g., the judgment creditor). This was the generally understood position taken by the Uniform Limited Partnership Act and many limited liability acts.
However, in Madison Hills Ltd. v. Madison Hills, Inc., a Connecticut court held that a judgment creditor of a limited partnership could foreclose on a partnership interest. The Connecticut court's holding opened the door for courts to provide a variety of remedies to creditors of partners in limited partnerships and members in LLCs. These additional remedies could result in forced dissolutions of the entities and the sale of their assets. The Alaska Legislature concluded that such results could be very harmful to the other partners or members, their families, and their business interests.
The newly enacted Alaska amendments make it clear that a judgment creditor of an Alaska limited partnership or limited liability company has only the remedy of a charging order. Thus, the creditor will receive all distributions made to the debtor partner or member. But, the right to receive such distributions is the judgment creditor's sole remedy. No other state law remedies are available to the judgment creditor or to a court implementing a creditor's collection request. However, a creditor may have additional remedies under federal bankruptcy law.
The strengthened creditor protection provided to these entities should make them even more popular for estate planning purposes. While many families are attracted to these entities for gift and estate tax reduction, creditor protection may prove to be an equally advantageous reason for their use.
Our Office is available to discuss with you the use of family limited partnerships and family limited liability companies in your estate planning.
SHAFTEL LAW OFFICES, P.C.
1029 West Third Avenue, Suite 600
Anchorage, Alaska 99501
FAX: (907) 278‐6015