A family partnership or LLC work for asset protection or tax planning only if you transfer assets from your name into the name of the entity. Transfer of assets into a partnership, or other entity, is often referred to as “funding” the entity. Partnership and LLC creators must decide which of their assets is appropriately held in the name of their FLP/LLC. In making the decision about funding, it is important that you understand the distinction between safe assets and liability assets. FLPs and LLCs should hold only safe assets.
Safe assets are those which are unlikely to invite their own liability. For example, passive ownership of publicly traded investment securities such as stocks, bonds, or mutual funds is unlikely to result in your being sued. Mere ownership of passive investment assets, without some active involvement in the underlying business, will not expose the owner to legal liability and civil judgments.
Liability assets, contrarily, are assets which, by their nature, create a substantial risk of liability. These assets generally involve the owners active participation and/or direct dealings with third parties. Examples of liability assets are rental real estate, commercial business partnerships, boats, or motor vehicles, any of which has inherent risks of legal disputes.
Asset protection planning uses FLPs and LLCs to protect valuable assets. If the asset protection entity itself incurs liability through ownership and operation of a dangerous asset, the entity will be the target of a lawsuit. If an FLP or LLC is named as a defendant in a lawsuit, all of the assets you sought to protect in the entity could be subject to the claims of the judgment creditor. Liability assets should either remain outside of the asset protection entity, or alternatively, these assets should be titled and operated in one or more special purpose entities. Asset protection isolates valuable safe assets from any and all potential liability assets.