So you’ve struck oil on your Texas land—or at least inherited some oil and gas interests. Congratulations! But as you bask in the glow of your newfound wealth, you’re probably wondering how to maximize and protect it.

The good news is that there’s a way to minimize—and sometimes even eliminate—some of the hefty taxes that come with oil and gas royalties, like estate, inheritance, and even income taxes. 

It’s through a unique estate planning tool called a Family Limited Partnership (FLP). 

What is an FLP?

An FLP is a legal entity in which family members pool their family assets into a single, unified entity to manage and protect them. This allows them to safeguard their wealth, maintain control over their assets, and smoothly transfer ownership across generations to build multigenerational wealth.

FLPs have two types of partners:

• General partners: General Partners have management control and are responsible for the partnership’s liabilities. They make decisions about the FLP’s investments and operations to meet family financial goals. We recommend these partners be a Management Trust or LLC. This can create liability protection and continuity of management.  
• Limited partners: Family members hold ownership interest but have no management authority. Their liability only extends to the amount they’ve invested into the partnership, protecting their personal assets from claims against the FLP.

This structure allows families to keep management control separate from ownership. This can be particularly beneficial for oil and gas interests because parents can retain control over these assets as general partners and gradually transfer ownership to their children as limited partners when the time is right. 

Advantages of FLPs for oil and gas interests

An FLP offers numerous benefits that can help you maximize and protect your oil and gas royalties, particularly when structured by knowledgeable estate planning professionals.

Higher level of protection

An FLP can shield your assets from creditors in a way that’s unique from other asset protection structures. If a creditor successfully pursues a lawsuit against you, they can’t seize your partnership interest and take control of your oil and gas royalties. They can’t attach to the mineral interests or working interests held by the partnership. 

Instead, they typically only receive what’s known as a charging order.

A charging order allows creditors to take a portion of your share of the income, but they don’t get any power, control, or voting rights within the partnership. They also only get distributions that are mandatory. In most cases, FLP is set up so that distributions are not mandatory. This makes it an unappealing asset for creditors, so they often negotiate settlements instead of pursuing claims against your FLP. 

Tax benefits

An FLP also offers substantial tax benefits for managing oil and gas interests. 

For starters, they allow estate and gift tax reductions. When you gift partnership interests to your children or other family members as limited partners, you can apply valuation discounts (more on this below) that reduce the overall value of the transferred assets for tax purposes. 

Furthermore, any income generated from your royalties within the FLP gets distributed among the partners. This allows it to be taxed at lower individual rates rather than steeper corporate rates. It also helps spread the tax burden among family members in lower brackets, which can improve your family’s tax position.

However, gifting and valuation discounts are limited and subject to control issues that can cause estate inclusion. 

Valuation discounts

Since oil and gas assets lack marketability and control, the value of the partnership interests can be discounted when you transfer the assets into the FLP. This valuation discount means that only a portion of transferred assets can be taxed, reducing your overall tax burden and often minimizing taxes by tens of thousands of dollars.

Disadvantages of FLPs for oil and gas interests

While FLPs can be beneficial to families with these unique assets, there are also limitations and complexities to consider before deciding if an FLP is right for your financial, business, and estate planning goals.

Complexity and cost

Establishing and maintaining an FLP involves legal counsel, appraisal, and ongoing administrative work to ensure compliance with regulations and proper partnership management. There are also intricate tax laws, drafting and updating detailed partnership agreements, and managing annual reporting requirements to deal with. 

These responsibilities are, well, a big responsibility and they come with a price tag. 

While these expenses are necessary to ensure appropriate management of your interests, it’s important to go into these arrangements knowing what to expect. Seeking legal counsel can help you understand your options and identify the right strategies to protect your interests.

Less liquidity and flexibility

Limited partners in an FLP can’t easily transfer their interests or liquidate their shares without adhering to the partnership agreement’s terms, which often include restrictions designed to keep the assets within the family. This can be problematic in the oil and gas industry since market conditions can change rapidly and you may need fast access to capital to seize new opportunities or manage downturns. 

This lack of flexibility in adjusting investments or responding to market changes can prevent you from maximizing the value of your oil and gas assets. 

How to know if an FLP is right for you

Deciding if an FLP is right for your oil and gas interests requires careful consideration of your unique circumstances and financial goals. Here are some key factors to consider:

• Asset size and type: FLPs are generally better for substantial holdings that require long-term management and protection rather than smaller or highly diversified portfolios.
• Need for control over assets: You can retain significant control over the partnership’s operations as a general partner, but limited partners have no say in management decisions. 
• Complexity: Consider how willing you are to manage the cost and complexity that comes with an FLP. If you’re prepared to work closely with an experienced business attorney and deal with the legal, tax, and operational complexities for the long haul, the pros may outweigh the cons.

By considering these factors, you can make an informed decision about whether an FLP is the right choice to protect your gas and oil interests.

Consult a Texas estate planning attorney

An FLP can be an amazing tool for protecting your wealth from oil and gas royalties and passing it down to future generations, but only if it’s structured correctly. And setting up and managing an FLP can be confusing and burdensome.

That’s why it’s so important to work with an experienced Texas estate planning attorney with deep knowledge of business law like those here at The Law Offices of Shann M. Chaudhry, ESQ. Our team can help you navigate these intricacies to ensure you meet all legal requirements and structure your partnership in the most tax-efficient manner. We can also guide you on the costs involved and help streamline the administrative process to save you time and money.

We care deeply about helping you protect and preserve the things that matter most to you—and helping you pass them down to the next generation. Contact our offices today to schedule a consultation and see how we can help you with your oil and gas interests.