FLPs as estate planning tools.

• Author: Medoff, Donna
• Position: Family limited partnerships

Family limited partnerships (FLPs) are popular tax and estate planning tools, became they provide many tax advantages. When used appropriately, they lower the taxable value of a decedent's estate; their assets are usually subject to a discount due to a lack of marketability and control. FLPs reduce income taxes, became income is spread across the partners. They also facilitate charitable and family gifting.

Sometimes, however, FLPs are used improperly, as shown in Est. of Thompson, TC Memo 2002-246, in which a FLP had little economic substance.

Facts

After meeting with financial planners, Thompson, along with son Robert, daughter Betsy and son-in-law George, created two FLPs and two corporations. These entities were created based on a specific estate plan called the "Fortress" under which, the family was informed, assets would be protected and income and estate taxes minimized.

Each corporation was an FLP general partner. In April 1993, the FLPs were funded with a significant majority of Thompson's assets, as well as some of the children's. Stock certificates were then issued. The two corporations maintained control over their respective FLPs.

On Thompson's death in 1995, a trust that had been in existence terminated, and the balance was paid to his heirs. Some of the FLPs' assets were liquidated and transferred to the estate to satisfy bequests and pay preliminary estate taxes. When these assets were exhausted, FLP interests were assigned to estate beneficiaries. Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, was then filed.

IRS's Position

The IRS issued a deficiency notice for a 40% discount taken for a lack of marketability and control. It also pointed to Sec. 2036(a), arguing that the FLPs lacked economic substance and that their activities were limited to supporting Thompson and providing cash for his annual gifts to his children, grandchildren and great-grandchildren. The FLPs also provided loans to those grandchildren and great-grandchildren.

Under Sec. 2036(a), transfers (except for bona fide sales for adequate and full consideration) in which the transferor continues to...