Validly formed FLP was recognized for estate tax purposes.

• Author: Fiore, Nicholas J.
• Position: Family limited partnerships

Individual S was a self-made millionaire, with four children and two stepchildren. In 1988, S executed a power of attorney, naming lawyer G (who was married to one of S's daughters) as his attorney-in-fact.

In 1993, after S underwent surgery, G took over S's affairs, pursuant to the 1988 power of attorney. After attending a seminar on the use of family limited partnerships (FLPs), in 1994, G formed SFLP, a Texas limited partnership, and its corporate general partner, Stranco, a Texas corporation. G then transferred S's assets to SFLP, in return for a 99% limited partnership interest. At the same time, S and his children bought all of Stranco's stock. Two months later, S died of cancer.

Following the formation of SFLP, various distributions were made to S's estate and to his children. In 1996, S's estate tax return was filed by G, the executor, reporting $2 million in transfer taxes.

The IRS challenged SFLP's existence, arguing that, under the business-purpose and economic-substance doctrines, it should be disregarded in valuing S's estate. In a reviewed decision, the Tax Court (opinion Cohen, J.) held that, because the FLP was validly formed under state law, it would be recognized for Federal estate tax purposes.

Taxpayers are generally free to structure transactions as they please, even if motivated by tax-avoidance considerations. However, the tax effects of a particular transaction are determined by the substance of the transaction rather than by its form. Transactions with no economic purpose or substance other than the avoidance of taxes will be disregarded.

Family partnerships must be closely scrutinized by the courts because the family relationship so readily lends itself to paper arrangements having little or no relationship to business arrangements. Family partnerships have long been recognized when there is a bona fide business carried on after the partnership is formed. Mere suspicion and speculation about a decedent's estate planning and testamentary objectives are not sufficient to disregard an agreement, in the absence of persuasive evidence it is not susceptible of enforcement or would not be enforced by parties to the agreement.

The estate contends that there were "clear and compelling" nontax motives for creating SFLP, including the provision of a flexible and efficient means by which to manage and protect S's assets. Specifically, the estate argues that its business purposes for forming SFLP were (1) to reduce executor and...