FLP Operations

MEMORANDUM REGARDING ADMINISTRATION OF YOUR FAMILY LIMITED PARTNERSHIP

1. Partnership Name. Should you desire to change the name or operate under a different name, please contact me, and I will advise you as to the changes which will be required. Although it is a regular practice, it is probably not best to use the family name in the partnership name. The Agreement of Limited Partnership provides the basic operating rules for the Partnership, and it should be consulted any time the Partnership intends to take action. When signing a document on behalf of the Partnership, the General Partner (or the Managing General Partner) must state beneath or opposite the General Partner's signature the full Partnership name and the capacity in which the General Partner is signing. You should use a format similar to the following:

[Full Name of the Limited Partnership, Printed]

By: _________________________________
[Name of the General Partner, Printed], General Partner

Changes made to the partnership law in 2005 allowed the use of an agent (such as "President") as the authorized person for a limited partnership, thus skipping the step of the limited partnership acting only through a general partner (that almost always is an entity itself), acting under signature of its agent. So, now a partnership organized in 2006 or later could have a signature like a corporation, as follows:

[Full Name of the Limited Partnership, Printed]

By: _________________________________
[Name of the Agent, Printed], President

            As a continuing matter of sound practice, I should be consulted any time you have a question about the operation of the Partnership. It is the responsibility of the General Partner to make certain that proper accounting practices are observed in a timely fashion. Accordingly, your accountant and I should be kept currently and consistently informed of all Partnership business activities.
            2.         Observation of Partnership Formalities. As you are aware, one of the major advantages of creating a Limited Partnership is the limited liability afforded to the limited partners who normally are not liable for the partnership’s debts and obligations beyond their interests in the Limited Partnership. Preservation of a limited partner’s limited liability depends to a large extent, however, on the proper observation of partnership formalities. Accordingly, it is extremely important that you maintain accurate and complete records of all activities of the Limited Partnership.
            In fact, the IRS has ignored many of the characteristics of a Limited Partnership in an estate tax context where the general partner treated the income as her own, depositing checks received by the Limited Partnership in question into her own personal account, even though there were numerous limited partners other than herself. If the business and affairs of a partnership are conducted without the required formalities, or if accurate and complete records are not maintained, a court or the IRS may choose to disregard the separate existence of the Limited Partnership. The limited partners could be held personally liable for the partnership’s obligations, or the valuation discounts provided by the appraiser could be ignored.
            3.         Accounting.     The Partnership will need to obtain a federal taxpayer identification number from the Internal Revenue Service. Your accountant can do this for you, but if you need my help, please tell me. You should be certain to seek advise as it pertains to matters related to the preparation and filing of tax returns, any distributions from the Partnership, or termination and dissolution of the Partnership. All assets transferred by the partners to the Partnership should be appropriately entered upon the books of the Partnership by you or your accountant. Any assets so transferred become the property of the Partnership.
            4.         Contributions. As you know, it is important that you transfer property to the Limited Partnership. Please do not forget that the general partners must in total maintain at least a 1% general partnership interest at all times. All property transferred to the Limited Partnership should be titled in the name of the new owner-the Limited Partnership. All property which the partners contribute to the Limited Partnership, as well as all property purchased by the Limited Partnership, should be styled with the name of the Limited Partnership.
            The first contribution to the Limited Partnership needs to be the dollar amounts identified in the agreement as the partners’ initial capital contributions. You should open a checking account in the name of the Limited Partnership at a bank with this cash. You will use the taxpayer identification number referred to in paragraph (2) above when opening the account. Subsequent contributions to the Limited Partnership can be made following the opening of that account.
            As have discussed, the types of assets that may be appropriate for transfer to this limited partnership include the following: non-homestead real estate, cash, securities (although it is generally best, as discussed more fully later in this memorandum, to maintain less than 80% of the partnership’s investments in marketable securities), partnerships, limited partnerships, life insurance and closely held businesses. Assets that should not be transferred to the limited partnership include: your homestead, qualified plans, IRAs, annuities, stock of an S corporation, most tangible personal property and heavily encumbered assets. Before you decide to transfer any property to the limited partnership, I would recommend that you check with me first.
            5.         Appraisal.       Since you may decide to make gifts of a portion of your Limited Partnership interest in the limited partnership, it is important to obtain an appraisal of the value of the partnership interests and, if necessary, the values of specific properties transferred to the Limited Partnership. I recommend that you enlist the services of a qualified appraiser to perform this task. Once the appraisal has been obtained, you can then proceed with transferring limited partnership interests to your intended beneficiaries. In addition, if the value of all gifts for the year to a single person exceeds $11,000 ($22,000 for a married couple) a United States Gift Tax Return should be filed to report these gifts.
            6.         Gifts.   When you are ready to make your gifts, if any, please contact me as additional paperwork will be needed. Specifically, you will notice that Exhibit “B” of the agreement contains a Subscription Agreement which must be signed by the Partners.
            7.         General Rules. In order to ensure your adherence to proper partnership formalities, I suggest you keep in mind the following general rules. You should be thoroughly familiar with the provisions of the Partnership Agreement, especially the provisions addressing duties of the partners. As we have discussed, the Agreement of Limited Partnership provides the basic operating rules for the Partnership, and it should be consulted any time the Partnership intends to take action. You should be sure to include in the Partnership’s record book copies of all documents which are executed regarding any of the following actions that the Partnership may undertake:

a. Acceptance of resignations of partners and admission of new partners

b. Transfers of interests in the Partnership

c. Appraisals of the valuation discounts

d. Changes of partnership name

e. Changes of partnership registered office of registered agent

f. Execution of major contracts

g. Purchases, sales or leases of real property

h. Changes in bank accounts

i. Borrowing or lending of money

j. Purchases or sales of partnership assets

k. Employment contracts

l. Any other partnership activities which you feel are significant.

             If the Partnership proposes to engage in a transaction affecting the basic structure or existence of the Partnership, I would strongly recommend that you consult my firm or such other attorneys as you may choose to ensure that all of the necessary documents are prepared, executed and, where necessary, filed with the appropriate governmental authorities.
            8.         General Partner’s Interest. The general partners should in total maintain at least a 1% general partnership interest at all times. For instance, if one or more limited partners make a contribution, you should make certain that a contribution from the general partners is not required to maintain the 1% interest.
             9.         Tax Returns and Other Filing Requirements. You should be sure to retain a knowledgeable accountant to help you with the tax returns which will be required for your Limited Partnership. It is crucial that all returns be filed timely. The following is a partial summary of the types of forms that are required and the deadlines associated with each. By April 15th of each year (unless extended), your Limited Partnership must file an IRS Form 1065. Attached to the Form 1065 are K-1s which let each partner know what his or her share of the profits or losses were for the prior tax year. If your Limited Partnership has employees, an IRS Form 941 and a Texas Workforce Commission report must be filed quarterly, and an IRS Form 940 must be filed at year end. IRS Form 1099s must be issued for many types of contract labor, interest or other types of consulting fees.
            If the Partnership plans to engage in retail or rental business or perform taxable services, it must obtain a Limited Sales Tax Permit from the Comptroller of Public Accounts for the State of Texas for each place of business it operates within the state. No Limited Sales Tax Permit will be issued by the Comptroller until the applicant provides the Comptroller with a bond or security, in an amount to be determined by the Comptroller.
            Numerous business activities and occupations are subject to licensing requirements or require the payment of occupational taxes or fees. If the Partnership is subject to such occupational taxes or fees, they should be paid prior to the commencement of business. Funds collected by a partnership as FICA taxes and payroll withholding taxes must be paid as provided by law, or the persons responsible for the failure to do so could be held personally liable. This liability is separate from that imposed upon the employer-partnership.
             10        Assumed Name Certificate. If the Partnership intends to transact business under a name other than its exact partnership name as indicated on its Certificate of Limited Partnership, an assumed name certificate must be filed (1) with the Secretary of State and (2) with the county clerk of the county in which the Partnership has its registered office as specified in the Certificate of Limited Partnership.
             11.       Ownership of Securities and Transfer of Appreciated Securities Section 721(a) of the Internal Revenue Code (the “Code”) provides that no gain or loss is recognized to a partnership or any of its partners for contributions of property to the partnership in exchange for an interest in the partnership. However, Section 721(b) of the Code provides that the non-recognition rule of Code Section 721(a) does not apply to contributions made to an investment company. Therefore, if your limited partnership is classified as an investment company, the contributor of appreciated securities to it will be required to recognize gain, unless other exceptions explained below apply. Once a contribution is made, what an investment company does with its assets later is irrelevant. For example, a subsequent sale or a purchase of other securities are not diversifying events because they are not contributions. Subsequent distributions of marketable securities, however, may result in gain recognition.
            A family limited partnership will be treated as an investment company if it holds more than 80% of the value of its assets for investment purposes. The following properties are now considered to be held for investment purposes: all securities or other equity interests (whether marketable or not); money; foreign currency; interests in Real Estate Investment Trusts, Regulated Investment Companies, common trust funds and publicly traded partnerships; instruments convertible into equity interests; precious metals; and other types of investments. You can completely avoid the recognition rule of Code Section 721(b) simply by arranging to fall below that 80% threshold. This means that if more than 20% of the investments owned by your limited partnership consist of assets such as real estate, then it will not be an investment company, and the nonrecognition rule will apply.
            The 80% mark is applied immediately after assets are transferred to the limited partnership and includes all “integrally planned” transfers. Thus, if several family members transfer investment assets at staggered points in time, the transfers may be viewed as an integrated plan, and the 80% measurement will not be applied until after the last contribution occurs and will include all earlier contributions. There is no time limit on what transactions can be considered part of a single plan.
            The rule requiring recognition of gain applies only if diversification takes place. A married couple should not have to recognize gain on appreciated contributed property if they own a large percentage of the limited partnership and if they are transferring identical assets to the limited partnership. Even if a partnership is treated as an investment company, a transferor is not required to recognize gain unless the transfer results in “diversification” of his or her transferred interests. Diversification occurs if two or more partners transfer different assets to the same limited partnership. As long as the transfers into a limited partnership will not diversify the transferor’s portfolio, there should not be any recognition of gain under Code Section 721(b) of the Code. Partners who transfer the same marketable securities to a limited partnership, even in different proportions, have not diversified their investment portfolios, and therefore, Code Section 721(b) should not apply. Married couples who transfer community property to a limited partnership are transferring identical interests (since they each own one-half of the transferred property) and they also have not diversified their investment portfolio, so no diversification takes place.
            Also, diversification will not occur if the portion of the contributed property which causes the diversification is insignificant, or “de minimis.” What is considered to be a de minimis diversification is not exactly clear. The regulations under the Code do make it clear that if 1% or less of the total contributions to a limited partnership cause the diversification, such a diversification can safely be considered to be de minimis. It would seem to be a valid conclusion that if over 95% of the interests of the limited partnership following the contribution of property to the limited partnership are owned by one individual or together by a married couple, then the limited partnership would fall under the de minimis exception. However, as more and more of the limited partnership is given away, the de minimis exception may no longer apply.
            In addition, new regulations provide guidelines to follow in determining whether there has been a diversification event for the investment company rules. Essentially, if the portfolio of marketable securities contributed to the partnership is already diversified, further diversification is irrelevant. Tax free transfers of marketable securities can be made if (1) not more than 25% of the value of the assets contributed by each partner are invested in the stock and securities of any one issuer; and (2) not more than 50% of the value of the assets contributed by each partner are invested in the stock and securities of five or fewer issuers.
            If a diversified contribution to an investment company is found to occur, gain is recognized, but loss is not. A partner who contributes appreciated property must report income equal to the excess of the value of the partnership interest received in the exchange over the adjusted basis of the assets transferred. Importantly, there should be no gain recognition to the partnership because the receipt of newly contributed property to the partnership is treated as a contribution to capital.
            It is also important to note that partnership anti-abuse regulations now allow the IRS to recast transactions where the principal purpose of the transaction is to reduce tax liability in a manner inconsistent with the partnership provisions of the Code. However, the new investment company regulations comprehensively deal with transfers of securities to partnerships, and the anti-abuse regulations should not apply when a family partnership arrangement is designed to avoid the specific provisions of Code Section 721(b).
             12.       Doing Business in Other States or Foreign Countries. If and when you consider doing business in other states or in other countries, you should consider the attendant qualification and income or other tax reporting requirements of that jurisdiction.

This memorandum contains general information and while the information presented is accurate as of the date of its publication, it cannot be relied upon as legal advice, as that can only be obtained through personal consultation with an attorney with whom you share your specific facts.

Last Updated: July 25, 2006