FLP transfers were bona fide.

• Author: O'Driscoll, David
• Position: Family limited partnerships

A's son E is the executor of her estate. In the years prior to her death, A transferred a large portion of her estate in a series of transactions to three entities:

1. A revocable living trust (T) created by A and administered by A and E as co-trustees.

2. A limited liability company (LLC), formed by A, E and his wife. T contributed $20,000 for a 50% interest. E and his wife each contributed $10,000 for 25% interests each.

3. A limited partnership (ALP) formed by T and the LLC. T contributed approximately $2.5 million in cash, oil and gas working interests and royalty interests, securities, notes and other assets, for a 99% pro-rata limited partner interest. The LLC contributed approximately $25,000 in cash for a 1% pro-rata general partner interest.

As a result of these transfers, A owned 99.5% of the partnership through the trust and the LLC. A retained over $450,000 in assets outside of the LLC and the partnership for her personal expenses.

The Estate Tax Return

At the time of A's death, the value of ALP partnership assets was approximately $2.4 million. On the return, the estate claimed a 49% discount on the value of A's ALP and LLC interests for lack of control and lack of marketability of the partnership interest. It reported her 99% partnership interest as having a fair market value (FMV) of approximately $1.2 million and her 50% interest in the LLC as having an FMV of approximately $17,000.

The IRS found that the value of the assets transferred to ALP and the LLC, rather than A's interest in these entities, was includible in the gross estate under Sec. 2036(a). The district court agreed; the estate appealed.

Analysis

Whether A's assets transferred to ALP must be recaptured into her estate for estate tax purposes depends on the application of Sec. 2036(a).That section prevents the circumvention of Federal estate tax by the use of inter vivos transactions, which do not remove the lifetime enjoyment of property purportedly transferred by a decedent. It provides two exceptions: first, it does not apply if the transfer is a bona fide sale for full and adequate consideration. The second exception applies if the decedent did not retain either the (1) possession, enjoyment or right to the transferred property or (2) the right to designate the persons who would possess or enjoy the transferred property.

Bona Fide Sale

The only case addressing the exception for a bona fide sale for full and adequate consideration in the Fifth Circuit, and the...