Partnership interest for services regs. offer estate planners a "bona fide" solution.

• Author: Cantrell, Carol A.

The IRS issued proposed regulations (REG-105346-03, 5/24/05) that clarify years of uncertainty as to how a partnership interest granted for services should be taxed under Sec. 83 and subchapter K. Granting partnership interests for services is a stranger to the estate planner's toolkit. However, the clarification may reveal a new opportunity in an unexpected area.

As estate planners know, the IRS is on the warpath against family limited partnerships (FLPs), claiming they are non-bona fide arrangements that should be ignored for estate tax purposes. It has been particularly successful in using Sec. 2036(a) to include transfers that decedents made during life for less than adequate and full consideration, in their gross estates; see Est. of Albert Strangi, TC Memo 2003-145, aff'd, 5th Cir., 8/8/05; Est. of Edna Korby, TC Memo 2005-102; Est. of Austin Korby, TC Memo 2005-103; Est. of Virginia A. Bigelow, TC Memo 2005-65; Est. of Wayne C. Bongard, 124 TC No. 8 (2005); Est. of Ida Abraham, TC Memo 2004-39, aff'd, 408 F3d 26 (1st Cir. 2005); Est. of Theodore R. Thompson, TC Memo 2002-246, aff'd sub nom Betsy R. Turner, 382 F3d 367 (3d Cir. 2004); Est. of Charles E. Reichardt, 114 TC 144 (2000); Est. of Morton B. Harper, TC Memo 2002-121; Est. of Eleanor T.R. Trotter, TC Memo 2001-250; and Est. of Dorothy M. Schauerhamer, TC Memo 1997-242. These IRS successes have caused practitioners to pay greater attention to using the Sec. 2036(a) bona fide sale exception to avoid estate inclusion. In that regard, granting partnership interests for services may offer a solution.

Permitted Services by Limited Partners

There are several types of services a limited partner may render without incurring liability as a general partner (GP) for "participating in the control" of a business. The Uniform Limited Partnership Act (1976) (ULPA), adopted in approximately 43 states plus the District of Columbia and the U.S. Virgin Islands, permits a limited partner to act in one or more capacities without violating this rule; see Uniform Limited Partnership Act (1976) with 1985 Amendments, Section 303, available at www.law.upenn.edu/bll/ulc/fnact99/1 980s/ulpa7685.htm. Such capacities include:

* Acting as contractor, agent or employee of the limited partnership or of a GP;

* Advising a GP on the limited partnership's business;

* Guaranteeing or assuming the limited partnership's obligations;

* Participating in a derivative action in the right of the limited partnership;

* Requesting or attending partner meetings;

* Voting or participating in the dissolution and winding up of the partnership; the sale, exchange, lease, mortgage, pledge or other transfer of partnership assets; the assumption of debt by the partnership other than in the ordinary course of business; a change in the nature of the business; the admission or removal of a partner; a transaction involving a conflict of interest among the partners and the partnership; an amendment to the partnership agreement or certificate of limited partnership, or other matters that the partnership agreement states may be subject to the approval or disapproval of limited partners; or

* Winding up the limited partnership under ULPA Section 803.

Because each state has adopted its own version of the ULPA, partners should determine which services their own state permits before entering into a partnership service contract. Further, about six states have adopted the Uniform Limited Partnership Act (2001) (Florida, Hawaii, Illinois, Iowa, Minnesota and North Dakota; pending in a few others), which eliminates the "control rule" altogether for personal liability for partnership obligations; see Uniform Limited Partnership Act (2001), Section 303, available at www.law.upenn.edu/bll/ulc/ulpa/final2001.htm. Thus, the 2001 Act provides a full, status-based liability shield for each limited partner, "even if the limited partner participates in the management and control of the limited partnership" (2001 Act, Section 303, at comment). This brings limited partners into parity with limited...