John Porter’s Partial Checklist of FLP ideas and tips

Summary: John Porter, the maestro of FLP and LLC litigation, offered some key planning tips for practitioners helping clients with FLPs and LLCs at the recent NYU Institute of Taxation in NYC. Here’s a few of them.

 ■ Document non tax reasons for the transaction. 2¢ Use the Dr. Phil, CPA approach “Make it real.” Adding a laundry list of reasons to the recital clauses of a partnership agreement won’t cut the mustard. Courts have looked through claimed non-tax reasons that had little substance.

■ Partnership agreement. Understand the terms of the agreement, and be certain that the terms are adhered to in the operation of the partnership. Example. The GP is required in the partnership agreement to disseminate partnership income tax returns no later than June 30^th of each year. If this is not done the IRS will argue a failure to adhere to the terms of the agreement. The boilerplate provisions must be adhered to. 2¢ Clients have a tough timing getting the message – when you’re done setting up the partnership, you need to sit down with your attorney, accountant, and investment manager (and anyone else involved in the operations and compliance for the partnership) and re-read the partnership agreement. The perspective is different when reading the agreement for operational directions then the focus when the agreement is initially finalized. Set up checklists of who will be responsible for what steps.

■ Accurate books and records. Some do it on Quicken, Quickbooks, others have CPA do it. However you handle it, the FLP must have an accurate P&L and balance sheet. 2¢ The cost of having a CPA who prepares the annual Form 1065 partnership income tax return also maintain regular books and records is really a modest incremental cost. The benefits of this for tax, asset protection, and even management and control, are significant.

■ Pro-rata distributions if required must be made. 2¢ This should be addressed proactively, not correctively. Have your advisers plan to avoid inappropriate distributions, not endeavor to clean up inappropriate transfers after the fact. An ounce of prevention is worth more than a pound of cure on this factor.

■ Never distribute all income. A retained right under 2036 is a retained right to income. In the Black case, most of dividends were distributed out to Mr. Black. Similar arguments appeared in the Schutt case.

■ No personal use assets should be held in the FLP.

■ Avoid “as needed” distributions. Example, no distributions for years then Mom wants to build a vacation home and a distribution is made before the purchase. “As needed” distributions that correlate with personal uses give the IRS fodder to argue that there was a retained right. If there is a cash flow need a better approach is to set up a distribution policy and distribute according to that policy on a regular basis. This might detract from discounts but may salvage the entity overall.

■ If family respects the integrity of the entity there is a good likelihood of success. Many of the 2036 cases the have been lost on bad facts.

■ Don’t give a senior family member sole distribution discretion.