FLPs as estate planning tools.
Sometimes, however, FLPs are used improperly, as shown in Est. of Thompson, TC Memo 2002-246, in which a FLP had little economic substance.
After meeting with financial planners, Thompson, along with son Robert, daughter Betsy and son-in-law George, created two FLPs and two corporations. These entities were created based on a specific estate plan called the "Fortress" under which, the family was informed, assets would be protected and income and estate taxes minimized.
Each corporation was an FLP general partner. In April 1993, the FLPs were funded with a significant majority of Thompson's assets, as well as some of the children's. Stock certificates were then issued. The two corporations maintained control over their respective FLPs.
On Thompson's death in 1995, a trust that had been in existence terminated, and the balance was paid to his heirs. Some of the FLPs' assets were liquidated and transferred to the estate to satisfy bequests and pay preliminary estate taxes. When these assets were exhausted, FLP interests were assigned to estate beneficiaries. Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, was then filed.
The IRS issued a deficiency notice for a 40% discount taken for a lack of marketability and control. It also pointed to Sec. 2036(a), arguing that the FLPs lacked economic substance and that their activities were limited to supporting Thompson and providing cash for his annual gifts to his children, grandchildren and great-grandchildren. The FLPs also provided loans to those grandchildren and great-grandchildren.
Under Sec. 2036(a), transfers (except for bona fide sales for adequate and full consideration) in which the transferor continues to possess or enjoy the income from the property, must be included in his or her gross estate. Thompson did not suspend his absolute title and enjoyment of such property. Not only were the assets used for his support and gifted at his request, but this usage was also implied at the FLPs' inception. The asset transfer was testamentary and, thus, includible in the gross estate.
The Tax Court decided in the Service's favor, determining that the FLPs were only a "recycling of value" without economic substance. Although a few investments had been made, the court found them executed with little research and without the prudence of a reasonable individual. In addition, the few income-producing activities paid income directly to the individuals involved, not to the FLPs.
The court's decision was based on several points:
1. The decedent continued to enjoy the assets transferred for the remainder of his life.
2. No legitimate business existed.
3. The assets contributed by other partners to the partnership were always held separately.
Thus, under Sec. 2036(a), the assets transferred by the decedent had to be included in their entirety, at fair market value, at the date of death.
FLPs can be an effective estate and gift planning vehicle. While they can serve to lower a taxable estate and to help lower income taxes by spreading income across partners, FLPs must meet the threshold requirement of a legitimate business enterprise.
FROM DONNA MEDOFF, CPA, GRAY, GRAY, & GRAY, LLP, BOSTON, MA
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|Title Annotation:||family limited partnerships|
|Publication:||The Tax Adviser|
|Date:||Dec 1, 2002|
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