Family Limited Partnerships: Continued Success in Tax Court
Family Limited Partnerships: Continued Success In Tax Court
Bruce Givner, Esq.
Givner & Kaye,
A Professional Corporation
12100 Wilshire Blvd., Suite 445
Los Angeles, California 90025
310-207-8008 begin_of_the_skype_highlighting 310-207-8008 end_of_the_skype_highlighting ; 818-785-7579 begin_of_the_skype_highlighting 818-785-7579 end_of_the_skype_highlighting
FAX 310-207-8708; 818-785-3027
For at least two decades taxpayers have been using family limited partnerships ("FLPs") to reduce the value of assets for gift tax purposes; to reduce the value of assets for estate tax purposes; and to gain a measure of asset protection. The IRS's original attack on FLPs was usually on the size of the discount taken for gifts of limited partnership interests. LeFrak v. Commissioner, T.C. Memo 1993-526 (1993). Now the weapon is Internal Revenue Code §2036, which allows the IRS to include in a deceased taxpayer's gross estate the value of gifts that are testamentary in nature. §2036(a) generally provides that if a decedent makes an inter vivos transfer of property other than a bona fide sale for adequate and full consideration and retains certain enumerated right or interest in the property which are not relinquished until death, the full value of the transferred property will be included in the decedent's gross estate. The early cases were relatively easy victories for the IRS because the taxpayers violated the terms of their own partnership agreements. Estate of Schauerhamer v. Commissioner, T.C. Memo 1997-242 (1997); Estate of Reichardt v. Commissioner, 114 T.C. 144 (2000). Since then there have been perhaps 3 dozen cases and the IRS has arguably prevailed in 80% of them. As a result, taxpayers and their advisors have gotten the impression that FLPs are "dead" as a tax planning structure.
Nothing could be further from the truth. First, a review of the published decisions quickly reveals that almost all of them involved obvious "bad" facts. For example, most of the IRS victories involve FLPs set up by taxpayers who were (i) already in their 90s or ii "only" in their 80s but had terminal illnesses. With this type of beginning fact it is easy to understand why (i) the IRS would argue that the FLP was only a testamentary device and (ii) a judge would be suspicious of the taxpayer's non-testamentary motives. Second, as experienced estate tax lawyers know, cases with good facts are not challenged by the IRS in the first place and cases with even decent facts receive favorable settlements in the IRS Appeals division. One of our matters involved a lady whose husband died in May, who had lived at home with 24 hour care for a decade, who formed an FLP in July, and died in August. Yet non-tax motives were apparent, documented and accepted by the IRS.
Now, early in 2012 we have striking evidence that FLPs, when properly structured and operated, will prevail in spite of IRS opposition, because the United States Tax Court handed victories to taxpayers twice in less than a month: Estate of Joanne Harrison Stone, T.C. Memo 2012-48 (February 22, 2012) Estate of Beatrice Kelly, T.C. Memo 2012-73 (March 19, 2012).
Mr. and Mrs. Stone had 6 adult children and lots of real estate in Tennessee. They intended to keep one particular property, referred to as the "woodlands parcels," as a "family asset." On advice of an attorney they formed a limited partnership to simplify the gift-giving process and guard against partition suits which would cause the property to be divided into smaller tracts. After three years of making gifts of limited partnership units, Mr. and Mrs. Stone - at the end of 2000 - only owned a 2% interest as general partners: the adult children owned the 98% limited partnership interests. Health was not a factor: Mrs. Stone taught Sunday School for 60 years, up to and including the last Sunday before she passed away at the age of 81, and Mr. Stone was 91 at the time of the trial in Tax Court. The issue before the court was whether the decedent had a legitimate and significant nontax reason for creating the FLP.
The IRS argued, and Tax Court Judge Goeke agreed, that gift giving alone is not an acceptable nontax motive for forming the FLP. However, creating a "family asset" to be managed by the family, even standing alone, is a sufficient nontax motive for purposes of IRC §2036(a) Also, even though the Stones had a testamentary purpose in mind, Judge Goeke noted that legitimate nontax purposes are often interwoven with testamentary objectives.
The Stones failed to respect some partnership formalities, e.g., they used a "bill of sale" to make gifts of limited partnership interests. However, other factors overwhelmed the defects. For example, Mr. and Mrs. Stone did not depend on distributions from the FLP; there was no commingling of partners' personal and partnership funds; and no discounting of limited partnership interests for gift tax purposes occurred.
The second case, Kelly, involved a bad fact from the beginning: Mrs. Kelly, the surviving spouse, was incompetent. However, the good facts also arose from the beginning: the four children recognized the real possibility of litigation among them that might occur on her death. Therefore, with Court approval they established separately limited partnerships to facilitate an equal division among them. Even though the court order confirmed that the multiple FLP approach would "avoid undesirable tax consequences," Tax Court Judge Foley did not see any evidence that tax savings motivated the structure. Importantly, Mrs. Kelly retained sufficient non-partnership assets for her personal needs and the family observed partnership formalities. This multiple partnership approach, as a way to a taxpayer victory, echoes what was done in Estate of Eugene Stone v. Commissioner, T.C. Memo 2003-309 (2003).
The lesson to be learned from the two recent taxpayer victories in Tax Court is that family limited partnerships are a powerful tool to achieve family business goals and objectives, including asset protection and, at the same time, gift and estate tax benefits. Taxpayers and their advisors should not hesitate to use FLPs - or FLLCs - in the appropriate circumstances simply due to a generalized fear that the "IRS does not like" this type of planning. An FLP that is properly created, documents and operated, will achieve non-tax goals and objectives and significant gift and estate tax savings, and will probably not be challenged by the IRS in the first place.