Forcing a square peg into a round hole damages both. Another flaw often found item during the discovery process is the “funding” of assets into the wrong vehicle. Certain vehicles have great use for specific business functions supported by statute, tax law, and case history. You and your planner must have a good handle on these issues and know what pros and cons each entity presents, what the effect on your liquidity will be and what it will take to maintain and support that stated business purpose as a start (starting to see the detail required?). One good example is the common misuse of Family Limited Partnerships (FLP) to own the client’s personal residence. What is the legitimate business purpose of using a vehicle that is most often created for “family investment management and wealth transfer” to own the house you personally live in? If you’re not paying the FLP commercially reasonable rent, you probably don’t have one. In this case the plaintiffs will successfully argue that you are using the FLP as personal piggy bank that is not legally distinct from you and your personal assets and liabilities and the I.R.S. won’t find it cute either.
Similarly, we often see dangerous articles of personal property like your personal vehicles moved into this structure or others like an LLC or S-Corp. that is your primary business; or equally dangerous, into an entity like an FLP that is holding safe and attractive assets like cash, stocks, bonds and other liquid assets. Think about it, if you lease or own your vehicle through your business, you have linked the most dangerous thing you likely do on a daily basis, i.e. drive a car, and linked it to either the source of your wealth, your business or in the case of your FLP, the place you keep your wealth. You are actually un-doing the protection and legal segregation of risks these structures may have provided. Many times the tax advantages override the liability because a deduction in the hand is real money. But owning assets in the wrong entity exposes assets unnecessarily.
Much of the content in this press release was taken from Ike Devji’s article Common Flaws of Asset Protection Planning with permission.