Family limited partnerships: the year in review.

• Author: Pratt, David

In November 2005, one of the authors co-authored an article for The Florida Bar Journal regarding family limited partnerships (FLPs), which focused on the most recent family limited partnership cases in the context of the bona fide sale exception to [section]2036 of the Internal Revenue Code of 1986, as amended. (1) About one year later, he co-authored a follow-up article for The Florida Bar Journal discussing FLP cases decided after the publication of the first article. (2) Since the publication of the follow-up article, there have been three [section]2036 cases involving FLPs (3)--the IRS was victorious in all of these cases. Each of these cases contains an abundance of "bad facts" (e.g., majority of assets transferred to the partnership, use of partnership funds for the transferor's personal expenses, the transferor is terminally ill or in very poor health upon formation, etc.).

The purpose of this article is to discuss these recent "bad fact" cases, Estate of Erickson v. Commissioner, T.C. Memo 2007-107; Estate of Gore v. Commissioner, T.C. Memo 2007-169; and Estate of Bigelow v. Commissioner, 100 AFTR 2d 2007-6016 (9th Cir. 2007), aff'd, T.C. Memo 2005-65, which continue to provide a roadmap for practitioners and clients regarding how not to structure and operate an FLP. The article then discusses the results of a Minnesota state court case in which the court held that a trustee did not have a fiduciary duty to establish an FLP. (4) Florida courts have not yet considered the issue, but it is hard to imagine that they would come to a different conclusion--although, anything is possible. Lastly, the article discusses recent changes to the Federal Estate Tax Return, Form 706, with respect to the reporting of valuation discounts and entity interests.

Estate of Erickson v. Commissioner

In May 2001, when Hilde E. Erickson was 88 years old, suffering from Alzheimer's, and in failing health, her daughter, Karen, orchestrated the creation of an FLP. The FLP agreement provided that Karen and her sister, Sigrid, would be both general and limited partners. Hilde (acting through Karen as her attorney-in-fact), Karen's husband, Chad Lange, and Karen, as trustee of the credit shelter trust created for Hilde's benefit under the will of Hilde's late husband, Arthur (the trust), would be limited partners. Hilde was to contribute virtually all of her personal assets, including $2 million of marketable securities and a Florida condominium, in exchange for an 86.25 percent interest in the FLP. Karen, Chad, and Sigrid were to each contribute partial interests in a Colorado investment condominium in exchange for a 1.4 percent, 1.4 percent, and 2.8 percent interest, respectively. The trust was to contribute another Florida condominium in exchange for an 8.2 percent interest, but it was not to contribute any of its $1 million in marketable securities.

No transfers to the FLP occurred upon the execution of the FLP agreement. In July 2001, Karen instructed Merrill Lynch and Wells Fargo to transfer Hilde's marketable securities to the FLP. On September 28, 2001, while Hilde's health was rapidly deteriorating, Karen executed deeds transferring Hilde's condominium and the trust's condominium to the FLP. On that same day, Karen, on behalf of Hilde, gifted a combined 62.07 percent limited partnership interest in the FLP to three trusts for Hilde's grandchildren. Hilde died two days later. After Hilde's death, the family continued to operate the FLP. The condominiums continued to be managed by the same onsite management companies, and the marketable securities continued to be managed by investment advisors at Merrill Lynch and Wells Fargo.

Karen was appointed as the personal representative of Hilde's estate pursuant to Hilde's will. The estate was unable to meet its liabilities for estate and gift taxes. Rather than obtaining the funds necessary to pay the taxes from the trust's $1 million in marketable securities, Karen sold Hilde's condominium to the FLP for $123,500 and transferred $104,000 from the FLP to the estate, the latter transfer being characterized as a partial redemption of Hilde's FLP interests.

The court's opinion first summarizes the principals of [section]2036. If a decedent makes an inter vivos transfer of property and retains certain rights or interests in the property, such as the right to possess or enjoy the property, that are not relinquished until death, the full value of the property will generally be included in the decedent's estate. (5) However, the bona fide sale exception will apply to exclude the property from the decedent's estate if the FLP was formed for a legitimate and significant nontax reason and each transferor received an FLP interest proportionate to the fair market value of the property transferred to the FLP. (6)

The court first considered whether Hilde retained the right to possess or enjoy the assets transferred to the FLP pursuant to an implied understanding among the partners. The court focused on the delay in funding the FLP and the need for the FLP to provide the estate with funds to meet its liabilities. The court believed that the funding, in part two months after the FLP's creation, and in part two months thereafter when Hilde was on her death bed, suggested a failure to respect the formalities of the FLP. The court also believed that the transfers of funds from the FLP to the...