FLPs receive boost: Fifth Circuit decision stems the tide of recent taxpayer losses.

• Author: Schiller, Keith
• Position: EstatePlanning; Family Limited Partnerships

The Fifth Circuit reversal in Kimbell v. U.S., Dec. 03-10529 (5/20/04) leaves the IRS bloodied, but unbowed, in its ongoing valuation discount struggle to expand retained interests principles to LLCs and family limited partnerships under IRC Section 2036.

The decision stems the recent tide of taxpayer losses on these issues.

Kimbell Case Background

The Kimbell appeal arose after the District Court granted a summary judgment for the IRS and denied the taxpayer's summary judgment request over the issues of whether or not the transfer of property to an FLP formed two months prior to death, in exchange for partnership interests, was for full and adequate consideration and whether or not the decedent had retained control under IRC Sec. 2036.

Two months prior to her death, Ruth Kimbell created an FLP with her revocable living trust as its 99 percent partner and an LLC as its 1 percent partner. The FLP was owned by the LLC and the decedent's revocable living trust.

Kimbell was the 50 percent owner of the LLC; her son (the petitioner in the case and manager of the LLC) and his wife each owned 25 percent of the balance.

The LLC contributed 1 percent of the capital and was the general partner while the trust contributed 99 percent of the capital. Valuation discounts of 49 percent underscore the case.

The decedent retained about $450,000 in cash outside of the entities. No elements of mismanaging assets, improper treatment of cash flow or failure to transfer assets were present.

IRC Sec. 2036(a) provides that an interest is included in the gross estate of a transferor who retains either the possession or enjoyment of, or the right to income from, the property, or the right, either alone or in conjunction with any person, to designate the persons who shall possess the property, or the income therefrom, unless the transfer was for full and adequate consideration.

What the Court Decided

Applying IRC Sec. 2036, the District Court considered (1) whether or not there was a bona fide sale in the transfer of assets to the partnership controlled by the son; and (2) whether or not an express or implied agreement existed that the decedent would retain the economic benefit of the property.

The District Court, citing Harper v. Comr. 83 T.C.M. 1641, found there was not a bona fide sale in the transfer of assets to the partnership because the sale was between related parties.

The District Court rejected the taxpayer's assertion that the partnership was governed by...