Proper Planning and Management Critical For FLP’s
Proper planning and hands-on management are critical to reduce the risk of IRS scrutiny on a family limited partnership or family limited liability company (hereinafter collectively referred to as “FLP’s”). A litany of cases exist as cautionary tales for what can go wrong without them. Estate of Shurtz v. Commission, T.C. Memo 2010-21, Docket No. 6076-07, decided on February 3, 2010 shows what they can accomplish when implemented properly. The estate planning undertaken in Estate of Shurtz transformed what was once a $9 million estate into an estate where no estate taxes were owed.
In Estate of Shurtz, the decedent formed multiple FLP’s and gifted fractional interests to her descendants or trusts for the benefit of her descendants over the course of years. The FLP’s were formed for valid business reasons, asset protection, management efficiency, and protection of family business from litigation. The partnership kept detailed financial records, issued K-1s, and filed Form 1065 every year. Additionally, the partnership held detailed annual meetings to discuss business strategies and its financial positions.
The IRS argued that the assets contributed to the FLP should be included in the decedent’s estate without discount under IRC Section 2036. IRC Section 2036(a) requires estates include assets wherein the decedent retained “the possession or enjoyment of, or the right to the income from, the property”. An exception exists to 2036 for the case of a bona fide sale for adequate and full consideration or money’s worth. The Estate countered that the bona fide exception applies and no estate tax was due.
The Court agreed with the Estate on all counts. First, the Court stated that the partnership was formed for legitimate non-tax reasons, meeting the bona fide sale exception. Further, the Court found the full and adequate consideration portion was satisfied because the partnership’s books properly created and maintained each partner’s capital account and distributions were properly distributed to partners. Since the Court found the bona fide sale for full and adequate consideration exception was satisfied, the fair market value of the assets contributed to the partnership were not included in the decedent’s gross estate.
Every step in the process from formation until after a person’s death is critical when creating an FLP. Where a legitimate business purpose or the proper documentation and management are lacking, problems with the IRS may arise under 2036. Where, as in the Estate of Shurtz, all steps are thoughtfully navigated, the ability to avoid and successfully defend an IRS challenge increase exponentially.
If you would like to discuss your FLP and how to best manage its affairs, please contact us.
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