FLPs and LLCs at risk.

AuthorAucutt, Ronald D.
PositionFamily limited partnerships and limited liability companies

A heads-up for CPAs involved in estate planning: A recent U.S. Tax Court decision may warrant your clients' reviewing the origin, operations, and ownership of their FLPs and LLCs to identify and explain possible risks.

The case of Estate of Albert Strangi v. Commissioner of Internal Revenue, T.C. Memo 2003-145, decided by the U. S. Tax Court on May 20, 2003, will have significant adverse effects on the tax consequences of the use of family limited partnerships (FLPs) and limited liability companies (LLCs). The Strangi case considered a family limited partnership created by Mr. Strangi and his family a couple of months before Mr. Strangi's death. With his son-in-law acting on his behalf under a power of attorney, Mr. Strangi retained a 99% limited partnership interest and 47% of the stock of the corporate 1% general partnership, for which he contributed to the partnership and corporation about 98% of his total assets, including his residence. The other 53% of the stock of the corporate general partner was purchased by other family members. Among other things, the partnership agreement provided that income from operations and capital transactions, after deducting certain expenses, "shall be distributed at such times and in such amounts as the Managing General Partner, in its sole discretion, shall determine, taking into account the reasonable business needs of the Partnership (including plan for expansion of the Partnership's business)."

The Tax Court ruled that 99.47% of the full date-of-death value of the partnership assets was included in Mr. Strangi's gross estate for estate tax purposes under Section 2036 of the Internal Revenue Code (IRC), and thus was subject to estate tax upon his death. This result, of course, undermined the principal tax objective of the estate planning involving his FLP, which was presumably to transfer as much wealth as possible in order to create an exclusion from estate tax.

Strangi's significance

In FLP and LLC cases prior to Strangi, taxpayer losses were generally confined to cases in which the taxpayer had been careless about respecting the structure and substance of the entity. Most estate planners have always advised clients to be careful in both creating and administering an FLP or LLC that all steps are properly documented and that all subsequent actions are consistent with the structure and governing documents of the entity. In Strangi, however, the partnership was properly formed and conducted...

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