FLP planning after Strangi, Kimbell and Thompson.

• Author: Eyberg, Terry
• Position: Family limited partnership

EXECUTIVE SUMMARY

* Since Byrum, the use of FLPs to transfer enormous amounts of wealth at minimal estate and gift tax costs has become a popular estate planning tool; the IRS has started to vigorously litigate eases it perceives as being highly abusive.

* Partnership agreements should be reviewed on a regular basis to ensure that their provisions conform to current Federal and state statutes.

* CPA financial planners should compute the amount of assets needed to be held outside the FLP, as well as the nontax financial benefits received by transferring assets to it.

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While tax advisers cheered the Fifth Circuit's pro-taxpayer decision on family limited partnerships in Kimbell, they are holding their collective breath far that court's decision in Strangi, and working to avoid another Thompson decision.

This article discusses these cases, their importance, the practitioner community's response and actions to take while awaiting the results of the Strangi settlement.

A transfer to a family limited partnership (FLP) is an example of an estate planning technique that has drawn the IRS's scrutiny. This article examines this strategy as it relates to retained rights under Sec. 2036(a)(1) and (2).

Transfers with Retained Life Estate

Sec. 2036(a), the general rule under Sec. 2036, Transfers with Retained Life Estate, provides:

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 the case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death--

(1) the possession or enjoyment of, or the right to the income from, the property, or

(2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom. (Emphasis added.)

Generally, the bona fide sale exception (the parenthetical language in Sec. 2036(a)) bars inclusion in the gross estate. Transfers that fall under this exception are exempt from Sec. 2036's application. However, to qualify, a two-prong test must he met; the transfer must be:

1. For adequate and full consideration; and

2. Bona fide.

   Cases

   Byrum

   In 1972, the Supreme Court issued Byrum, (1) a landmark decision involving retained rights under Sec. 2036. The Court focused on the fiduciary duties of a majority shareholder and director; it concluded that Sec. 2036(a)(2) only reached those rights for which the decedent controlled beneficial enjoyment, and which were legally enforceable under state law. Since then, FLPs have become a popular estate planning tool to transfer enormous wealth at minimal estate and gift tax costs (after valuation discounts). As a result, the IRS now vigorously litigates FLP cases it perceives as being highly abusive.

   Strangi

   The IRS enjoyed a recent victory on retained rights in Est. of Strangi, (2) a decision on remand from the Fifth Circuit, which is currently being appealed by the taxpayer to the Fifth Circuit. Strangi is probably one of the more noteworthy cases to be decided thus far in the retained rights realm.

   On remand, the Tax Court held that the decedent retained sufficient beneficial enjoyment of a FLP's assets so as to cause inclusion in his estate under Sec. 2036(a)(1). Further, the court held that the assets could have been included under Sec. 2036(a)(2), because the decedent, through his attorney-in-fact, reserved control over beneficial enjoyment. The FLP's corporate general partner, who was managed by the decedent's attorney-in-fact, had complete control over distributions. The Tax Court concluded that the decedent's ability to control FLP distributions and to join with the other partners to cause a partnership liquidation, constituted sufficient control to cause inclusion of the assets in his gross estate under Sec. 2036(a)(2). This so-called "alternative ruling" in the IRS's favor, holding that the decedent's interests were includible via Sec. 2036(a)(2), was particularly intriguing.

   Kimbell

   Following closely behind Strangi was the Fifth Circuit's decision in Kimbell, (3) rendered on May 20, 2004. The court vacated a district court's holding that the decedent's transfer to a partnership was not a bona fide sale for adequate and full consideration. The Fifth Circuit also vacated the district court's grant of partial summary judgment as to whether the decedent retained an interest in property transferred to her limited liability company (LLC); it remanded the case for a determination on whether the decedent's interest in the partnership was an assignee or a limited partnership (LP) interest.

   Facts: In the months immediately preceding her death, Ruth A. Kimbell entered into a series of transactions to reduce her taxable estate. First, in January 1998, she created the R.A. Kimbell...