FLPs v. Tax Courts: Bongard case highlights Family Limited Partnership challenges.

• Author: Lieberman, Philip R.
• Position: Estate planning

The IRS has challenged family limited partnerships on a number of grounds, without much success, in recent years.

Recent cases against FLPs rely on violations under Sec. 2036(a), where the IRS disputed the unchanging relationship between the donor and the assets transferred to the FLP.

But a recent ruling in Bongard v. Commissioner, (124 TC No. 8), provides an analysis of the Tax Court's interpretation of Sec. 2036(a) and its applicability in establishing an FLP.

Past IRS Scrutiny

Many early FLP challenges focused on the applicability of restrictions on control and transfer of interests within the partnership agreement. These restrictions are what appraisers rely on to support valuation discounts.

Most notable was the IRS use of Sec. 2704(b) and Reg. 25.2704-2(a) in challenging the validity of FLPs. The 5th Circuit Court's decision in Kerr v. Commissioner, (292 F.3d 490, 89 AFTR 2d 2002-2838), helped dissuade the IRS from continuing on this path.

Another avenue the IRS has tried with some success focused on the annual gift tax exclusion under Sec. 2503(a) and whether a gift of a partnership interest is itself entitled to the benefit of the annual gift tax exclusion.

In Hackel v. Commissioner, [118 TC 279 (2002)], the IRS argued that a gift of a partnership interest is not really a transfer of (present) value since it is subject to restrictions on transferability and is reliant on the general partner for income distributions.

The IRS was successful, but the win did not hinder the will of advisers. While the case is being appealed, planners must consider its implications and structure partnership agreements accordingly.

The Evolving Sec. 2036 Challenge

In certain instances, where a taxpayer retains the right to the assets subsequent to the transfer, the IRS has argued that their full value should be included in the donor's estate. Early cases where the IRS had success using Sec. 2036(a) include Reichardt v. Commissioner, [114 TC 144 (2000)], and Strangi v. Commissioner [115 TC 478 (2000)].

Raising the Bar

Cases subsequent to Reichardt and Strangi have gone one step further. Recent rulings describe the need for a legitimate (non-tax) business purpose for the partnership, such as management expertise, security and preservation of assets, and avoidance of personal liability.

The Bongard Case

Wayne C. Bongard, a successful business owner, died in 1998. His estate's 706, filed Feb. 15, 2000, reported that the federal estate tax owed was...