FLP litigation: have Strangi and Bongard provided clarification, guidance on FLPs?

• Author: Weintraub, William M.
• Position: Family limited partnerships

For years, taxpayers and estate planners have enjoyed relative certainty in using family limited partnerships as an effective means of transferring assets at reduced estate tax costs to the next generation. Largely, this resulted from applying discounts for estate tax purposes in valuing fractional interests that are retained by a deceased transferor.

In a typical case, courts apply a combined discount in excess of 30 percent for lack of control and lack of marketability. However, in several relatively recent cases, the IRS has argued successfully that the transfer of assets to an FLP should be disregarded by applying Internal Revenue Code Sec. 2036(a).

Under this approach, the contribution of assets to an FLP is disregarded for estate tax purposes. Instead, the decedent is treated as the owner of the assets transferred or contributed to an FLP. As a result, these assets, not the partnership interests, are subject to valuation and the assets valued for estate tax purposes are not subject to a discount.

Recent case law provides clarification of some of the issues and affords guidance in planning for successful use of FLPs.

IRC SEC. 2036(A)

IRC Sec. 2036(a) includes in a decedent's gross estate those assets that were transferred during life, but to which the transferor retained significant rights. The retained rights may relate to either the transferor's use of the property or enjoyment of the income from the property, or to the ability to designate the persons who could use the property or benefit from its income.

IRC Sec. 2036(a) reads:

"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 there from."

Recent cases have focused on the application of Sec. 2036(a)(1) and the exception to the application of Sec. 2036(a) for transfers constituting bona fide sales for full and adequate consideration.

In all cases there is never an express reservation of the "possession or enjoyment of, or the right to the income from" the property contributed to an FLP. Rather, courts look to the facts and circumstances to determine whether there was an implied right retained. Also, the courts have developed fairly clear standards for when the exception to the application of Sec. 2036(a) applies for bona fide sales for full and adequate consideration.

Two cases from 2005, Strangi v. Commissioner and Estate of Wayne C. Bongard v...