Tax Court Rules That Assets Transferred to FLP Are Includible in Gross Estate | BNA

A recent Tax Court ruling has interesting implications for people who have set up Family Limited Partnerships (FLP) as part of their estate planning. Bureau of National Affairs (BNA) contributing analyst, Deborah M. Beers with Buchanan Ingersoll & Rooney PC, has written an analysis of the case. The background of the case reads like many I’ve seen with clients here in Mississippi. Mom and Dad form an FLP and each retain a 0.5% general partnership interest and a 49.5% limited partnership interest. There was a governing agreement, appraisals, and documentation of limited partnership transfers to their children and grandchildren. According to the BNA article,

The partnership agreement was a form agreement used by the law firm that advised the Turners with regard to their estate planning. The agreement recited a laundry list of “business purposes,” including three general purposes, as follows: (1) to make a profit; (2) to increase the family’s wealth; and (3) to provide a means whereby family members can become more knowledgeable about the management and preservation of the family’s assets. To facilitate the general purposes, the partnership agreement listed nine specific purposes for formation of Turner & Co., a number of which had no application to the Turners.

After Dad died and his Form 706 filed, the IRS argued that the full value of both his retained interest AND the prior transfers be included in his gross estate under §§2035, 2036, and 2038, or twice what had been reported on his 706. The Tax Court agreed, stating in part that the non-tax business reasons for establishing the FLP were “illusory.” The application of 2036A(1) and 2036A(2) was successful because it was demonstrated that Dad had control over the assets in the FLP, had comingled personal and business expenses within the FLP, had taken “extraordinarily high management fees”, and had power to determine who could ultimately enjoy the assets in the FLP.

Since I am not an attorney, I must be missing something here. Isn’t control one of the reasons for creating an FLP and retaining a general partnership interest? And as the trust officer for trusts that hold FLP limited partnership interests where Mom or Dad are the general partner, I have paid my fair share of expenses that looked an awful lot like personal expenses to me. It also appears that the Service is looking a lot more closely at the work being performed for those management fees that Mom and Dad are earning. What’s the appropriate standard? The tax attorneys I’ve worked with have all warned their clients that the IRS is specifically targeting FLP’s and remind them to manage an FLP just like it was a business. I wonder how many are heeding their advice.

Turner Est. v. Comr.

Tax Court Rules That Assets Transferred to FLP Are Includible in Gross Estate | BNA