FLP issues and opportunities.

• Author: Holtz, Joan C.
• Position: Family limited partnerships

Several recent cases have challenged the formation and administration of family limited partnerships (FLPs). If generally applied, two of these, Est. of Harper, TC Memo 2002-121, and Est. of Thompson, TC Memo 2002-246, could have serious repercussions on personal financial and estate planning. Given how significant FLPs are, this column analyzes these cases' failures and suggests how they may reveal some planning opportunities to CPAs.

Sec. 2036

Both cases examined the role Sec. 2036 played in FLP formation and administration. Sec. 2036 addresses transfers with retained life estates and the estate tax implications therefrom. Under Sec. 2036(a), "the value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale ...," under which he or she retains "(1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right ... to designate the persons who shall possess or enjoy the property or the income therefrom."

This creates problems for taxpayers who want to minimize exposure to estate taxes, but not transfer total control or enjoyment of their assets. Traditionally, FLPs have served as a technique for equalizing the tension between these two objectives.

Harper---Economic Benefits Retained

Facts. In June 1994, at age 86, the decedent formed a FLP with his son and daughter and later transferred a portfolio of investments to it. The FLP's primary purpose was "the acquisition, including by purchase of, sale of, management of, holding, investing in and reinvesting in stocks (both common and preferred), ... bonds" and other financial assets. Under the agreement, the taxpayer's son was managing partner, with essentially complete authority to manage and control all business decisions. However, the agreement significantly restricted his ability to make major decisions (e.g., admission or removal of a general partner (GP)); such decisions required approval of over 50% of the FLP interests (i.e., there was a veto power).

A certificate of limited partnership (LP) was filed on the FLP's behalf with California in June 1994. Shortly thereafter, the taxpayer was hospitalized with acute cancer. In July, after his release from the hospital, he transferred 60% of the LP interests to his two children. His transfer of his investment portfolio to the FLP also commenced in July and took four months to...