Family Limited Partnerships And Valuations And Estate Tax Consequences Recent Cases Part 1
Copyright (c) 2010 Jeffrey Matsen
Over the previous few years or so, there had been numerous instances determined regarding Family Limited Partnerships and Limited Liability Companies and valuation troubles or inclusion within the federal gross estate pursuant to Section 2036 (retain entertainment or control). These instances have raised numerous issues worth of have a look at and review of which practitioners should be conscious.
The Section 2036 Cases
Section 2036(a) gives:
The fee of the gross estate shall include the price of all assets to the volume of any interest therein of which the decedent has at any time made a switch (except in case of a bona fide sale for an adequate and full attention in cash or money’s really worth), through trust or otherwise, below which he has retained for his existence or for any duration no longer ascertainable without connection with his dying or for any length which does no longer in truth stop before his death ‘
(1) the ownership or amusement of, or the right to the income from, the assets, or
(2) the right, either on my own or together with any character, to designate the humans who shall possess or revel in the belongings or the earnings therefrom.
The IRS 2036(a) role
(a) A transfer of property to the Family Limited Partnership is not a bona fide sale for an adequate and full attention of money or cash’s really worth; and
(b) The Decedent retained ownership, entertainment or proper to income from the assets within the FLP and the proper to designate the people who could possess or experience such assets.
In U.S. V. Byrum, 408 US one hundred twenty five (1972), the Supreme Court held that the Decedent did now not preserve the proper in the that means of Section 2036(a)(2) to designate who become to revel in the consider profits and discussed how numerous prison and economic constraints on the Decedent’s retention of management manage did no longer quantity to a legal right. The Court drew a distinction between designating individuals who could own or revel in belongings or earnings and the energy this is subject to outdoor constraints. Query whether or not Byrum stands for the proposition that a majority owner of an employer is not dealt with as having, for functions of Section 2036(a), a legally enforceable proper to decide the go with the flow of profits from the business enterprise.
Estate of Morton B. Harper, TC Memo 2002- 121, 83 TCM 1641, May 15, 2002
Decedent changed into in unwell health whilst he shaped a California Family Limited Partnership and died approximately 8 months later. Originally the Decedent had a ninety nine% hobby but it was reduced within a count number of weeks by way of presents to 39%. Funding of the FLP turned into accomplished in most cases with securities and the profits therefrom turned into obtained inside the Decedent’s non-public account rather than the FLP’s. The Court held that only felony identify changed and emphasised the failure to comply with the formalities of the Partnership Agreement which includes commingling the price range, a history of disproportionate distributions to the Decedent, and the reality that there had been too many testamentary characteristics of the asset transfer to the FLP.
Estate of Theodore R. Thompson, TC Memo. 2002-246, 84 TCM 374, September 26, 2002
The Court agreed with the IRS that the property transferred by using the Decedent to 2 Limited Partnerships were includable in his Estate beneath 2036(a)(1) because of retained enjoyment of the property. The Court’s opinion emphasised the shortage of any legitimate enterprise elements worried within the formation of the Partnerships and said that the belongings have been merely recycled. Where there is most effective a recycling that doesn’t look like encouraged mostly by legitimate business issues, no switch for consideration inside the which means of 2036(a) takes place
Turner v. Commissioner No. 03-3173 (3rd Cir. 2004) affirming Estate of Thompson above.
The Court held that marketable securities transferred with the aid of a decedent to Family Limited Partnership, which the Estate discounted for loss of manage and marketability have been includible in Decedent’s property because an implied agreement existed among the Decedent and his own family that the Decedent might keep entertainment and economic gain of the transferred assets. The Court additionally concluded that the Decedent’s transfers (an insignificant recycling of fee) to the Family Limited Partnership did no longer represent bona fide sales in the that means of Section 2036(a) because the Decedent did not replenish his Estate with different property of identical fee and said that even though a bona fide sale does no longer necessarily require an fingers period transaction between the transferor and an unrelated 0.33 party, it nonetheless need to be made in good religion. A true religion transfer to a Family Limited Partnership should offer the transferor some capability for advantage apart from the capability estate tax advantages than would possibly end result from keeping assets within the Partnership form. The Court mentioned that this sort of dissipation of fee within the estate tax context ought to cause heightened scrutiny into the real substance of the transaction wherein the transferee Partnership does now not operate a legitimate business and the report demonstrates the valuation bargain offers the sole advantage for changing liquid, marketable assets into illiquid partnership pastimes.
David A. Kimbell v. U.S. 93AFTR 2nd 2004 – 2400 (fifth Cir, 2004) vac’g and rem’g 244F Supp. Second seven-hundred
The fifth Circuit, in vacating and remanding the District Court Case, held that the assets the Decedent transferred to a consider, an LLC and to an FLP had been now not includible in the Estate underneath Section 2036(a), but as a substitute the transfer become a bona fide sale for good enough and full consideration. The Court agreed with the IRS that a bona fide sale takes on heightened importance in an inter family switch, but held that there has been no additional requirements below Section 2036 for such transfers. The fifth Circuit stated that the willing customer-willing dealer take a look at for fair marketplace value is different from the adequate and complete consideration under Section 2036(a). The Court mentioned the subsequent records supported the lifestyles of a bona fide sale: a. The Decedent retained sufficient belongings outside the Partnership for her own support and there was no commingling of Partnership and her non-public property;
B. Partnership formalities had been happy and the property were assigned to the Partnership;
C. Assets contributed to the Partnership blanketed operating pursuits in oil and fuel properties which require active management; and,
D. The Estate’s witnesses superior several credible and unchallenged non tax business motives for the formation of the Partnership that could not be accomplished via the Decedent’s accept as true with by myself.
Estate of Strangi TC Memo 2003-one hundred forty five (May 20, 2003) (Stangi II)
In Stangi II the FLP paid all of the 24 hour homecare expenses of the Decedent right now prior to his dying as well as for his surgical operation fees and the Decedent’s funeral, estate management costs and the property and inheritance taxes. The Court depended on the reality that the Corporate General Partner although now not technically managed via the Decedent (simplest a forty seven% possession hobby), had entered into a management settlement with his son who was the holder of the Decedent’s Power of Attorney so that the disbursements of finances from the FLP have been basically the movements of the Decedent acting through his Attorney-in-Fact. The Strangi II opinion is regarded by many practitioners as a vast enlargement of the reach of 2036(a)(2) because the Court talked about that the formalities have been adhered to.
Planning Suggestions to Avoid Applicability of 2036(a):
A. Valid enterprise cause for established order of FLP.
B. Strict adherence to cash distribution allocations.
C. Significant different possession hobbies.
D. Sound accounting principals and practices adhered to.
E. Fiduciary popular required of General Partner.
F. The quicker the better with respect to the establishment of the FLP earlier than the dying of the transferor.
G. Consider having unbiased General Partner or children act as General Partners.
H. Do now not vicinity power to remove or pick General Partner with the transferor.
I. Do now not fund FLPs with non-public assets.
J. Real estate is higher than securities and coins.
As stated, those cases have raised several problems worth of take a look at and evaluation of which practitioners must be conscious. Look for a continuation of this newsletter entitled: Family Limited Partnerships and Valuations and Estate Tax Consequences Recent Cases Part 2.