Source: http://www.mccarthyfingar.com/attorneys/howell-bramson/speaking-engagements/irs-attacks-on-family-limited-partnershi2.aspx
Timestamp: 2019-04-23 18:21:40+00:00

Document:
The IRS has been challenging the use of Family Partnerships on a number of fronts.
I. Implied reservation of a life estate in property transferred to a family limited partnership (FLP).
A. Estate of Lea K. Hillgren v. Commissioner, T.C. Memo 2004-46 (Mar. 3, 2004). Tax Court concluded that value of properties transferred to limited partnership was includible under §2036(a). Decedent was treated for mental illness beginning in 1984. Around October 1996, decedent ended her relationship with a boyfriend. On October 31, 1996, decedent attempted to commit suicide by overdose of medications, alcohol and carbon monoxide poisoning. On March 21, 1997, she was admitted to a hospital for pain in her arm and neck; she was taking five different medications, and suffered degenerative disc disease of the cervical spine. On June 5, 1997, at the age of 41, decedent committed suicide.
B. Estate of Abraham, T.C. Memo 2004-39 (Feb. 18, 2004). Good example of what not to do. In 1993, Ida Abraham, the decedent, was placed under a guardianship; two daughters were appointed permanent guardians; and the two daughters petitioned the probate court for authority to make gifts from decedent’s funds not needed for her maintenance and support (reason given was that decedent’s estate “is likely to be subject at her death to . . . taxes at the highest marginal tax rates then in effect”). The probate court granted the request.
C. Estate of Stone v. Commissioner, T.C. Memo 2003–309 (Nov. 7, 2003). Unique facts. The Stones transferred certain assets, including real estate and family holding company stock, to 5 FLPs only two months before Mr. Stone’s death in 1997. The process which led to the funding of the partnerships started in 1992 with the onset of litigation among the Stones’ children over the family’s assets. The children had become actively involved in managing the assets in 1995 by which time the parents had lost interest in such matters. Final settlement of the litigation coincided with the funding of the partnerships.
D. Estate of Strangi v. Commissioner, 115 TC 478 (2000), aff’d in part and rev’d and remanded in part, 293 F.3d 279 (5th Cir. 2002) (known as Strangi I) and Estate of Strangi v. Commissioner, T.C. Memo. 2003-145 (May 20, 2003) (known as Strangi II). Decedent’s son-in-law, an estate planning attorney who also held the decedent’s power of attorney, formed an FLP two months before decedent’s death. After formation, the son-in-law transferred about $2 million of decedent’s assets to the FLP in exchange for a 99% limited partnership interest. The general lpartner, which owned 1% of the partnership, was a corporation in which decedent owned a 47% interest. Decedent’s children owned the remainder of the corporation’s shares, but for a 1% share, which was owned by a charitable foundation. The partnership agreement gave the general partner the sole discretion to determine distributions. Decedent has used partnership assets to pay for personal expenses, including nursing care. At his death, decedent’s FLP interests comprised more than 96% of his estate. Decedent’s estate tax return included the 99% limited partnership interest, but with a 43.75% discount for lack of marketability and minority interest. The IRS determined a deficiency in estate and gift tax, largely on the basis that the decedent’s interest in the FLP should have been increased for estate and gift tax purposes. The IRS claimed, in part, that Code Sec. 2036(a) ought to apply to assets the decedent had transferred to the FLP due to his retained interest in, and control of those assets.
E. Harper, Morton B. Est, (2002) TC Memo 2002-121 (May 14, 2002). The Tax Court said this case bore many similarities to Schauerhamer and Reichardt. The Court also held that assets which a decedent transferred to an FLP (from his revocable trust) were includible in the decedent's gross estate because there existed an implied agreement that the decedent would retain the economic benefit of the assets transferred to the FLP. The decedent was initially named as the sole limited partner and his two children were designated as general partners. The decedent later gave his children 24% and 36% limited partnership interests, respectively. At his death, the decedent continued to hold a 39% limited partnership interest in the FLP. In support of its conclusion that there was an implied agreement that the decedent would retain the economic benefit of all the FLP's assets, the court focused on (1) the commingling of funds, (2) the history of disproportionate distributions, and (3) the testamentary characteristics of the arrangement.
F. TAM 9938005 (June 7, 1999). The IRS determined that the value of closely-held stock transferred by the decedent to a family limited partnership is includible in the decedent’s gross estate under Code Section 2036(b), because, in his capacity as general partner, the decedent retained the right to vote the stock. Two brothers each owned a 50% interest in a corporation. The corporation had a revolving credit agreement with a bank and under the agreement the brothers had to devise a plan of management and ownership. The brothers each transferred 55% of their stock to a family limited partnership. Each brother retained the right to vote the stock as general partners. One of the brothers transferred some of his partnership units to his four children and placed his remaining units in a revocable trust whereby the trust assets passed to his children on his death. When the brother died, the trust held his partnership units and 22.5% of the outstanding stock in the corporation. The Service determined that the decedent transferred his stock for less than adequate consideration because he did not receive all of the consideration for his transfer of stock to the partnership. In addition, the transfer to the partnership, which was designed to produce an estate freeze, could not be characterized as a bona fide sale. Since the decedent retained the right to vote the stock as a general partner, the Service concluded that the stock was includible in his gross estate.
G. Estate of Reichardt v. Commissioner, 114 T.C. 144 (2000). The Tax Court held that the property an individual transferred to a family partnership was includible in his gross estate under Code Section 2036(a) because he retained the enjoyment of the property during his lifetime. Reichardt continued to be the only person with the authority to sign partnership checks and documents and continued to live at his residence even after transferring it to the partnership and he commingled partnership and personal funds. The Tax Court found that the Reichardt and his children had an implied agreement that he could continue to possess and enjoy the assets, and retain the right to the income from the assets. Fourteen months before his death, the decedent formed a revocable living trust and an FLP. The decedent appointed himself and his two children as co-trustees and authorized each trustee to act on behalf of the trust. The decedent was entitled to receive the net income of the trust at least annually, and he was entitled to use the trust corpus for his support, maintenance, health, and general welfare. The trust was the FLP's only general partner.
(1) The decedent, in violation of the partnership agreements, deposited the income from the FLPs into the account used by her as a personal checking account, where it was commingled with income from other sources. According to the Tax Court, deposits of income from transferred property into a personal account were highly indicative of “possession or enjoyment”.
(2) The decedent's children acknowledged that the formation of the FLPs was merely a way to enable the decedent to assign interests in the partnership assets to members of her family, and that the assets and income would be managed by the decedent exactly as they had been managed in the past. According to the Tax Court, where a decedent's relationship to transferred assets remains the same after the transfer as it was before the transfer, Code Sec. 2036(a)(1) requires that the assets be included in estate.
A. TAM 9944003 (July 2, 1999). The Service ruled that gifts of limited partnership interests constitute gifts of present interests that will qualify for the annual exclusion under code Section 2503(b). Under the terms of the Partnership Agreement in the case, the general partners are solely responsible for the management of the partnership business and the timing and amount of any distributions are within the sole discretion of the general partnership. The agreement gives the limited partner the right to assign his or her partnership interest. The National Office ruled that the gifts of limited partnership interests to the children of the general partner constitute an outright gift of ownership interest in the partnership and each donee received the immediate use, possession and enjoyment of the interest, including the right to sell or assign the interest, which thus constitute present interests that qualify for the annual gift tax exclusion.
B. Hackl v. Commissioner, 118 T.C. 14 (March 27, 2002). The Tax Court ruled that the gift of LLC membership units by a husband and wife to their children and grandchildren failed to qualify for the annual gift tax exclusion because the donees did not have the immediate use, possession, or enjoyment of the LLC units. The opinion concludes that the LLCs operating agreement prevented the donees from obtaining any immediate substantial economic benefit from the LLC units because the donees could not (1) unilaterally withdraw their capital account, (2) sell their units without the approval of the LLC’s manager, or (3) effectuate a dissolution of the LLC by themselves. The Court also accepted the contention that the donees did not have the immediate use, possession, or enjoyment of the income from the LLC units because the LLC not expected to produce immediate income, and any income generated would only be distributed at the manager’s discretion. The Court rejected the Hackls’ argument that when a gift takes the form of an outright transfer of an equity interest in property, no further analysis is needed or justified.
IV. Guidelines For Creating and Operating FLPs.
1. Organize and fund FLP before death is eminent.
2. Do not transfer substantially all of the taxpayer’s assets to the FLP. Retain sufficient assets to provide support outside of the FLP. Don’t treat FLP as if its your personal bank account.
3. Respect all formalities of the FLP and the FLP agreement. Prepare and execute minutes for all significant FLP decisions, election of officers, etc.
4. Establish valid, supportable reasons for establishing the FLP (in addition to tax advantages) - liability limitations, avoidance of ancillary probate, unified management of assets, creating a relatively simple mechanism to use to make gifts.
5. Transfer assets promptly after formation of FLP. Make sure corporate or individual GP transfers assets for its interest.
6. Fund FLP with assets requiring ongoing management (e.g., real estate or interests in a closely held business) rather than just passive investment assets. If only passive investment assets are available or appropriate, document the reason for the existence of the FLP, such as to provide creditor protection, centralized investment authority, or take advantage of investment opportunity not available on a smaller scale.
7. Do not transfer personal use assets to the FLP. If transferred, discontinue any personal use after the transfer, or pay the FLP fair market rent for the use of any FLP asset.
8. If possible, have more than one partner make significant contributions to the FLP.
9. Transfer and title all FLP assets properly in the name of the FLP.
10. Do not transfer FLP interests until all FLP assets have been properly transferred to the FLP.
11. Establish, maintain and use separate bank and/or brokerage account for the FLP.
12. If possible, have more than one general partner. If general partner is an entity, entity should be controlled by more than one individual.
13. Require general partner to: (a) prepare and distribute annual financial statements, (b) calculate capital accounts annually, and (c) adjust percentages of ownership for distributions to, or capital contributions by, partners. Make sure all actions taken by/for FLP are taken in its name.
14. Make distributions of income pro rata to all partners (unless partnership agreement specifically provides for non-pro rata distributions).
15. Do not waive general partner’s fiduciary duties in the partnership agreement.
16. Do not use FLP funds to pay personal expenses of the partners.
17. Avoid loans to partners.
18. Make sure that any compensation paid is reasonable.
19. Make all federal and state filings for the FLP in a timely manner.
20. If required, file gift tax return on timely basis, reporting the gift of an FLP interest and attach copy of qualified appraisal of the gifted interest.

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