Appeals Courts Back IRS in FLP Cases
Three federal courts of appeals (the First, Third, and Fifth Circuits) have upheld Tax Court rulings in favor of the IRS, concluding that assets transferred to family limited partnerships (FLPs) should be included in the transferors' estates. These cases serve as a reminder of what not to do with an FLP, such as commingling assets, improperly planned distributions, personal use of FLP property.
In July 2005, the Fifth Circuit affirmed the Tax Court decision in Strangi that assets transferred to an FLP were includible in the estate based on an implied agreement. During his lifetime, Strangi occupied the residence after transferring it to the FLP and received substantial monthly payments out of the FLP. After his death, the FLP paid funeral and estate administration expenses, Strangi's personal debts, and specific bequests. However, the circuit court did not rule on the Tax Court's broad interpretation of whether the transferor retained the "right to control" who will enjoy the benefit of the property and/or its income. (See ruling.)
In Abraham (May 25, 2005), the First Circuit also affirmed the Tax Court holding that property transferred on behalf of an incapacitated individual to three FLPs was includible in her gross estate, finding an implied agreement to use the income from the transferred property for the Alzheimer's victim's support. The Third Circuit followed suit in Turner, Executrix, as did an earlier Fifth Circuit Case, Kimbell.
However, the taxpayer prevailed—at least in part—in a recent Tax Court case, Bongard (Mar. 15, 2005) may be appealed to the Eighth Circuit. The Court held that the shares transferred to a holding company as part of a plan to raise capital for the corporation need not be included in the transferor’s estate because there was a legitimate and significant non-tax reason for the transfer. However, the court held that the value of the LLC units transferred to a family limited partnership must be included because there was no similar reason for that transfer.
For help in avoiding these pitfalls, check the AICPA Trust, Estate, and Gift Tax TRP's Checklist of Issues to Consider in Yearly Administration of Family Limited Partnerships.