Family Limited Partnerships By Robert J. Kiggins, Esq. of McCarthy Fingar, White Plains, NY...

Family Limited Family Limited PartnershipsPartnerships

By Robert J. Kiggins, Esq. of By Robert J. Kiggins, Esq. of McCarthy Fingar, White McCarthy Fingar, White

Plains, NYPlains, NY

Presented on June 10, 2005Presented on June 10, 2005

INTRODUCTIONINTRODUCTION How does FLP work as wealth transfer planning mechanismHow does FLP work as wealth transfer planning mechanism

Primarily a discounting mechanism for transfers of property interestsPrimarily a discounting mechanism for transfers of property interests

Example Example client has 100,000 shares of Microsoft and wants to gift 10,000 shares to client has 100,000 shares of Microsoft and wants to gift 10,000 shares to a junior family member (e.g. son)a junior family member (e.g. son)

At $25 per share this would be a $250,000 giftAt $25 per share this would be a $250,000 gift However, if client gifts the MSFT to Family LLP or LLC and son has only 10% interest in the However, if client gifts the MSFT to Family LLP or LLC and son has only 10% interest in the

LLP the value of the gift may well be less than $250,000 on account of minority interest LLP the value of the gift may well be less than $250,000 on account of minority interest discounts.discounts.

Example Example client owns 100,000 shares of auto dealership (“Auto’) worth $2.5 M and client owns 100,000 shares of auto dealership (“Auto’) worth $2.5 M and wants to transfer these at death to son at discounted value for estate taxwants to transfer these at death to son at discounted value for estate tax

Pre-death sets up LLPPre-death sets up LLP Transfers 99,000 Auto to LLP for 99% capital interestTransfers 99,000 Auto to LLP for 99% capital interest 1,000 Auto sold to son for FMV of $25K and son puts them into LLP for 1% capital interest1,000 Auto sold to son for FMV of $25K and son puts them into LLP for 1% capital interest Son Runs LLP as GPSon Runs LLP as GP At death, client’s 99% LLP interest (assume $25 per share) will be valued at less than At death, client’s 99% LLP interest (assume $25 per share) will be valued at less than

$2,475,000 (99,000 x $25)$2,475,000 (99,000 x $25) Reason: lack of control discounts Reason: lack of control discounts

What Else Does FLP What Else Does FLP AccomplishAccomplish

It May be A Way to Prevent Family It May be A Way to Prevent Family Business from Breakup through Business from Breakup through SplinteringSplintering

It may also provide some protection from It may also provide some protection from creditors (limited liability)creditors (limited liability)

May offer economies of scaleMay offer economies of scale May be a way of dealing with family May be a way of dealing with family

disputesdisputes However, the discounting effect is the one However, the discounting effect is the one

that we will focus on todaythat we will focus on today

Rationale for DiscountsRationale for Discounts Minority or Lack of Control Discounts:Minority or Lack of Control Discounts:

Business ownership is a bundle of rights.Business ownership is a bundle of rights. A controlling co-owner may obligate other owners. A controlling co-owner may obligate other owners. Elements of control may include Elements of control may include

appointment of management and determination of appointment of management and determination of compensation;compensation;

deciding articles, bylaws and policy making/changing deciding articles, bylaws and policy making/changing acts;acts;

acquire and liquidate assets; selection and termination of acquire and liquidate assets; selection and termination of business relationships;business relationships;

liquidate, dissolve, sell out or re-capitalize company; sell liquidate, dissolve, sell out or re-capitalize company; sell or acquire treasury shares; or acquire treasury shares;

register for a public offering register for a public offering and declare and pay dividendsand declare and pay dividends

Rationale for DiscountsRationale for Discounts The distinguishing characteristic of a partial interest is co-The distinguishing characteristic of a partial interest is co-

ownership.ownership. This co-ownership can diminish benefits This co-ownership can diminish benefits

due to lack of control and liquiditydue to lack of control and liquidity may eventually entail disputes among owners, which may only be may eventually entail disputes among owners, which may only be

resolved through the expensive process of litigation. resolved through the expensive process of litigation. Once any of these rights are encumbered, it is likely to have an impact Once any of these rights are encumbered, it is likely to have an impact

on value. on value. Unless there are special laws in placeUnless there are special laws in place

a controlling partnership interest is worth much more than a non-a controlling partnership interest is worth much more than a non-controlling one; controlling one;

especially, an assignee interest with no voting rights. especially, an assignee interest with no voting rights. In the absence of such control, a In the absence of such control, a discount discount is often taken for the is often taken for the

inability to unilaterally influence the business or its investment inability to unilaterally influence the business or its investment performance. performance.

This is often referred to as a This is often referred to as a non-controllingnon-controlling or or minority discountminority discount. . Also these interests tend to be unattractive and difficult to marketAlso these interests tend to be unattractive and difficult to market These discounts can be significant and are supported by various These discounts can be significant and are supported by various

market studies and case precedentmarket studies and case precedent

IRS AttacksIRS Attacks

IRS attacks are currently being made under IRS attacks are currently being made under §2036(a) §2036(a) which pulls back into decedent’s estate transfers: which pulls back into decedent’s estate transfers:

where decedent retained income interests (Sec 2036 (a) where decedent retained income interests (Sec 2036 (a) (1)), or (1)), or

where decedent retains right to direct beneficial where decedent retains right to direct beneficial enjoyment of income of transferred property (Sec 2036 enjoyment of income of transferred property (Sec 2036 (a)(2)(a)(2)

In a series of cases courts held that decedent in In a series of cases courts held that decedent in connection with FLP’s had retained an income connection with FLP’s had retained an income interest in the transferred assetsinterest in the transferred assets

Also some of these cases held decedent had right Also some of these cases held decedent had right to direct beneficial enjoymentto direct beneficial enjoyment

IRS AttacksIRS Attacks Estate of Strangi v. CommissionerEstate of Strangi v. Commissioner, 115 TC 478 (2000), aff’d in part and , 115 TC 478 (2000), aff’d in part and

rev’d and remanded in part, 293 F.3d 279 (5th Cir. 2002) (known as rev’d and remanded in part, 293 F.3d 279 (5th Cir. 2002) (known as Strangi IStrangi I) and ) and Estate of Strangi v. CommissionerEstate of Strangi v. Commissioner, T.C. Memo. 2003-145 , T.C. Memo. 2003-145 (May 20, 2003) (known as (May 20, 2003) (known as Strangi IIStrangi II).).

FactsFacts Decedent’s son-in-law, an estate planning attorney who also held the 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 decedent’s power of attorney, formed an FLP two months before decedent’s death.death.

After formation, the son-in-law transferred about $2 million of decedent’s After formation, the son-in-law transferred about $2 million of decedent’s assets to the FLP in exchange for decedent’s receipt of a 99% limited assets to the FLP in exchange for decedent’s receipt of a 99% limited partnership interest.partnership interest.

Decedent also received a 47% interest in the corporate general partner, Decedent also received a 47% interest in the corporate general partner, which owned 1% of the partnership,. which owned 1% of the partnership,.

Decedent’s children received 53% the corporation’s sharesDecedent’s children received 53% the corporation’s shares But then gave a 1% share to a charitable foundation. But then gave a 1% share to a charitable foundation.

The partnership agreement gave the general partner the sole discretion to The partnership agreement gave the general partner the sole discretion to determine distributions.determine distributions.

Decedent used partnership assets to pay for personal expenses, including Decedent used partnership assets to pay for personal expenses, including nursing care. nursing care.

At his death, decedent’s FLP interests comprised more than 96% of his At his death, decedent’s FLP interests comprised more than 96% of his estate.estate.

Decedent’s estate tax return included the 99% limited partnership interest, Decedent’s estate tax return included the 99% limited partnership interest, but with a 43.75% discount for lack of marketability and minority interest. but with a 43.75% discount for lack of marketability and minority interest.

IRS AttacksIRS Attacks The IRS determined a deficiency in estate and gift taxThe IRS determined a deficiency in estate and gift tax

Largely on the basis that the decedent’s interest in the FLP should Largely on the basis that the decedent’s interest in the FLP should have been increased for estate and gift tax purposes. have been increased for estate and gift tax purposes.

The Partnership itself was a restriction under Section 2703 which The Partnership itself was a restriction under Section 2703 which should be disregardedshould be disregarded

The IRS claimed, in part, that Code Sec. 2036(a) ought to apply:The IRS claimed, in part, that Code Sec. 2036(a) ought to apply: to assets the decedent had transferred to the FLPto assets the decedent had transferred to the FLP due to his retained interest in, and control of those assets. due to his retained interest in, and control of those assets.

The Tax Court in The Tax Court in Strangi IStrangi I as to Sec. 2703 held that the FLP was as to Sec. 2703 held that the FLP was valid under state law:valid under state law:

because the entity complied with all necessary formalities, and because the entity complied with all necessary formalities, and because the partnership had sufficient substance to be recognized for because the partnership had sufficient substance to be recognized for

tax purposes. tax purposes. However, the Tax Court did note that it was skeptical of the non-However, the Tax Court did note that it was skeptical of the non-

tax avoidance reasons for formation of the FLP.tax avoidance reasons for formation of the FLP. The Tax Court refused to consider the Code Sec. 2036(a) issue The Tax Court refused to consider the Code Sec. 2036(a) issue

because the IRS had asserted the issue too close to the trial date. because the IRS had asserted the issue too close to the trial date. The Fifth Circuit upheld the majority of the Tax Court’s findings, The Fifth Circuit upheld the majority of the Tax Court’s findings,

but remanded on the 2036(a) issue.but remanded on the 2036(a) issue.

IRS AttacksIRS Attacks On remand, in Strangi II, the Tax Court:On remand, in Strangi II, the Tax Court:

held that Code Sec. 2036(a) applied to assets transferred by decedent to the held that Code Sec. 2036(a) applied to assets transferred by decedent to the FLPFLP

because decedent because decedent implicitly retained economic benefitimplicitly retained economic benefit from the transferred from the transferred property - 2036(a)(1),property - 2036(a)(1),

including the right to receive the income therefrom. including the right to receive the income therefrom. Also decedent impliedly kept right to designate persons who would enjoy beneficial Also decedent impliedly kept right to designate persons who would enjoy beneficial

use of the property – Sec 2036(a)(2)use of the property – Sec 2036(a)(2) Thus, the decedent’s entire 99% limited partnership interest and 47% Thus, the decedent’s entire 99% limited partnership interest and 47%

interest in the corporate GP was included in his estate without discountinterest in the corporate GP was included in his estate without discount Crucial to the court’s decision under 2036(a) (1) were the following Crucial to the court’s decision under 2036(a) (1) were the following

facts:facts: Decedent died two months after the FLP was created;Decedent died two months after the FLP was created; Decedent transferred substantially all of his assets to the FLP;Decedent transferred substantially all of his assets to the FLP; Decedent’s attorney-in-fact controlled the FLP;Decedent’s attorney-in-fact controlled the FLP; FLP assets were used for decedent’s personal expenses; andFLP assets were used for decedent’s personal expenses; and No other partner had a meaningful economic interest in the FLP.No other partner had a meaningful economic interest in the FLP. Decedent, through his attorney-in-fact, retained the right to determine who Decedent, through his attorney-in-fact, retained the right to determine who

would benefit from the assets and the income generated therefrom.would benefit from the assets and the income generated therefrom. Implied agreement existed among the partners of the FLP to allow the Implied agreement existed among the partners of the FLP to allow the

decedent to retain the use and enjoyment of, or the income from, the decedent to retain the use and enjoyment of, or the income from, the underlying assets. underlying assets.


Crucial to the court’s decision under Crucial to the court’s decision under 2036(a) (2) were the following facts:2036(a) (2) were the following facts: The decedent acting with others could The decedent acting with others could

have the partnership liquidatedhave the partnership liquidated If all the LP’s and the GP agreedIf all the LP’s and the GP agreed GP could consent to a P/P liquidation if all GP could consent to a P/P liquidation if all

shareholders voted for itshareholders voted for it Decedent acting with co-shareholders Decedent acting with co-shareholders

could control P/P Distributionscould control P/P Distributions


Note: full inclusion of all P/P assets Note: full inclusion of all P/P assets was required under Sec. 2036(a)(2)was required under Sec. 2036(a)(2)

CF: under Sec 2036(a)(1) only pro-CF: under Sec 2036(a)(1) only pro-rata inclusion would normally be rata inclusion would normally be requiredrequired Example - if a trust is created by X, and X Example - if a trust is created by X, and X

retains the right to received 2% of the retains the right to received 2% of the trusts income, then, only 2% of the trust trusts income, then, only 2% of the trust corpus is included in X’s gross estate corpus is included in X’s gross estate under 2036(a)(1)under 2036(a)(1)

Stone Case - Bona Fide Stone Case - Bona Fide SaleSale

Estate of Stone v. CommissionerEstate of Stone v. Commissioner, TCM 2003-309 , TCM 2003-309 FACTS FACTS

The Estate of Stone examined five family limited partnershipsThe Estate of Stone examined five family limited partnerships formed just two months prior to the death of Mr. Stone and six formed just two months prior to the death of Mr. Stone and six

months prior to the death of Mr. Stone's wife.months prior to the death of Mr. Stone's wife. At the time of Mr. Stone's death, he held the majority of the general At the time of Mr. Stone's death, he held the majority of the general

partner and limited partner interests in each of the family limited partner and limited partner interests in each of the family limited partnerships as follows: partnerships as follows:

FLP #1 - 69.973% (inclusive of a 1.001% general partner interest) FLP #1 - 69.973% (inclusive of a 1.001% general partner interest)






The day prior to the formation of the partnerships, small undivided The day prior to the formation of the partnerships, small undivided interest gifts were made to each of the Stone's children. interest gifts were made to each of the Stone's children.

Each partnership held different real properties and other assets, Each partnership held different real properties and other assets, including some preferred stock in the family operating company. including some preferred stock in the family operating company.

On the date of formation, each of the Stone children received, in On the date of formation, each of the Stone children received, in return for their respective contributions, small general partner return for their respective contributions, small general partner interests.interests.

In each case, just enough general partner interest was provided to In each case, just enough general partner interest was provided to Mr. Stone such that he held a simple majority of the general Mr. Stone such that he held a simple majority of the general partner interests. Ms. Stone held only limited partner interests.partner interests. Ms. Stone held only limited partner interests.

The estate tax returns were filed claiming, in aggregate, 43-The estate tax returns were filed claiming, in aggregate, 43-percent lack of control and lack of marketability discounts on Mr. percent lack of control and lack of marketability discounts on Mr. Stone's interests.Stone's interests.

Moreover, four of the five partnerships made non-pro rata Moreover, four of the five partnerships made non-pro rata distributions to the estate for the direct purpose of paying Mr. distributions to the estate for the direct purpose of paying Mr. Stone's estate tax. Stone's estate tax.

It took the IRS only three months from the estate tax filing to pick It took the IRS only three months from the estate tax filing to pick up the estate of Stone's §706 for audit. up the estate of Stone's §706 for audit.


IssueIssue both parties agreed a transfer took place, both parties agreed a transfer took place, the Court's decision hinged on whether or the Court's decision hinged on whether or

notnot the transfer qualified under the bona fide sale the transfer qualified under the bona fide sale

exception to §2036, aexception to §2036, a if not did the decedent retain possession or if not did the decedent retain possession or

enjoyment of, or the right to income from, the enjoyment of, or the right to income from, the property transferred property transferred


Bona Fide Sale Exception Bona Fide Sale Exception

The IRS asked the Court to rule there was not a bona fide sale, in part, The IRS asked the Court to rule there was not a bona fide sale, in part, because: because:

..a transfer is a sale for adequate and full consideration only if that received ..a transfer is a sale for adequate and full consideration only if that received in exchange is "an adequate and full equivalent reducible to money value." in exchange is "an adequate and full equivalent reducible to money value." Treas. Reg. §20.2036-1(a) (cross-referencing Treas. Reg. §20.2043-1(a))Treas. Reg. §20.2036-1(a) (cross-referencing Treas. Reg. §20.2043-1(a))

The average 43-percent valuations discounts claimed on estate tax returns, The average 43-percent valuations discounts claimed on estate tax returns, and the stipulated discounts to be applied in valuing Decedents' limited and the stipulated discounts to be applied in valuing Decedents' limited partner interests in the event the Court concluded that section 2036(a)(1) partner interests in the event the Court concluded that section 2036(a)(1) was not applicablewas not applicable

show that Stones admittedly do not consider interests in the Stone LPs to be the show that Stones admittedly do not consider interests in the Stone LPs to be the "full equivalent reducible to a money value” of the proportionate amount of the "full equivalent reducible to a money value” of the proportionate amount of the underlying assets Decedents contributed to the partnershipsunderlying assets Decedents contributed to the partnerships

Court rejected to the IRS argument:Court rejected to the IRS argument:

Mr. Mr. StoneStone and Ms. and Ms. StoneStone received respective partnership interests in each of the received respective partnership interests in each of the Five Partnerships the value of which, taking into account appropriate discounts, Five Partnerships the value of which, taking into account appropriate discounts, was less than the value of the respective assets that they transferred to each such was less than the value of the respective assets that they transferred to each such partnership, they did not receive adequate and full consideration for the assets partnership, they did not receive adequate and full consideration for the assets transferred.transferred.


IRS argument in effect read out of IRS argument in effect read out of section 2036(a) the exception for "a bona fide sale for the exception for "a bona fide sale for an adequate and full consideration in money or money's worth" in any case an adequate and full consideration in money or money's worth" in any case

where there is a bona fide, arm's- length transfer of property to a business entity (e.g., a where there is a bona fide, arm's- length transfer of property to a business entity (e.g., a partnership or a corporation)partnership or a corporation)

for which the transferor receives an interest in such entity (e.g., a partnership interest or stock) for which the transferor receives an interest in such entity (e.g., a partnership interest or stock) that is proportionate to the fair market value of the property transferred to such entity and that is proportionate to the fair market value of the property transferred to such entity and

the determination of the value of such an interest takes into account appropriate discounts. the determination of the value of such an interest takes into account appropriate discounts.

In reaching its decision, the Tax Court explicitly considered the following facts: In reaching its decision, the Tax Court explicitly considered the following facts:

Each member of the Stone family was represented by his or her own Each member of the Stone family was represented by his or her own independent counsel independent counsel

Each member had input into the decision-making as to how each of the Five Each member had input into the decision-making as to how each of the Five Partnerships was to be structured and operated and what property was to be Partnerships was to be structured and operated and what property was to be transferred to each such partnership.transferred to each such partnership.

The Stone family understood that Mr. Stone and Ms. Stone would not be bound by any The Stone family understood that Mr. Stone and Ms. Stone would not be bound by any agreements that the children were able to reach as a result of the children's agreements that the children were able to reach as a result of the children's negotiations and that Mr. Stone and Ms. Stone would make the ultimate decision as to negotiations and that Mr. Stone and Ms. Stone would make the ultimate decision as to which, if any, of their respective assets to transfer to each of the Five Partnerships (i.e. which, if any, of their respective assets to transfer to each of the Five Partnerships (i.e. the kids weren’t running the show) the kids weren’t running the show)


- The Stones did not transfer "all their respective assets to such - The Stones did not transfer "all their respective assets to such partnerships. Instead, they retained sufficient assets to enable them to partnerships. Instead, they retained sufficient assets to enable them to maintain their respective accustomed standards of living." maintain their respective accustomed standards of living."

- the respective transfers at issue did not constitute gifts by Mr. Stone - the respective transfers at issue did not constitute gifts by Mr. Stone and Ms. Stone...." (i.e., the transfers in exchange were pro-rata) and Ms. Stone...." (i.e., the transfers in exchange were pro-rata)

All partners of each of the Five Partnerships held respective partnership All partners of each of the Five Partnerships held respective partnership interests in each such partnership that were proportionate to the fair interests in each such partnership that were proportionate to the fair market value of the assets that such partners respectively transferred to market value of the assets that such partners respectively transferred to each such partnership;each such partnership;

the respective assets that the partners of each such partnership transferred the respective assets that the partners of each such partnership transferred to each such partnership were properly credited to the respective capital to each such partnership were properly credited to the respective capital accounts of such partners; andaccounts of such partners; and

upon the termination or dissolution of each of the Five Partnerships, the upon the termination or dissolution of each of the Five Partnerships, the partners of each such partnership were entitled to distributions from each partners of each such partnership were entitled to distributions from each such partnership in amounts equal to their respective capital accounts. such partnership in amounts equal to their respective capital accounts.

The transfers were motivated primarily by investment and business The transfers were motivated primarily by investment and business concerns relating to the management of certain assets of Mr. Stone concerns relating to the management of certain assets of Mr. Stone and Ms. Stone during their livesand Ms. Stone during their lives

the Five Partnerships had economic substance and operated as joint the Five Partnerships had economic substance and operated as joint enterprises for profit through which the children actively participated enterprises for profit through which the children actively participated in the management and development of the respective assetsin the management and development of the respective assets

there was a genuine pooling of property and servicesthere was a genuine pooling of property and services


the partnerships were formed such that it was "contemplated and intended that the partnerships were formed such that it was "contemplated and intended that each such partnership operate as a joint enterprise for profit for the management each such partnership operate as a joint enterprise for profit for the management of its assets and the children contribute services in providing such management.of its assets and the children contribute services in providing such management.

after the funding of [the partnerships, the respective children] actively after the funding of [the partnerships, the respective children] actively participated in the management of the assets of such partnerships.“participated in the management of the assets of such partnerships.“

Court concluded Court concluded the respective transfers of assets by Mr. Stone and Ms. Stone to each of the Five the respective transfers of assets by Mr. Stone and Ms. Stone to each of the Five

Partnerships were for adequate and full consideration in money or money's worth.Partnerships were for adequate and full consideration in money or money's worth.

Moreover, "we find, that unlike the transfers involved in Estate of Harper and Moreover, "we find, that unlike the transfers involved in Estate of Harper and other cases factually similar to that case, the respective transfers at issue by Mr. other cases factually similar to that case, the respective transfers at issue by Mr. Stone and Ms. Stone did not constitute 'circuitous 'recycling' of value.'" Stone and Ms. Stone did not constitute 'circuitous 'recycling' of value.'"

Retention of Possession or Enjoyment Retention of Possession or Enjoyment

Finally, because the transfers met the bona fide sale exception to §2036, it Finally, because the transfers met the bona fide sale exception to §2036, it was not necessary for the Tax Court to consider whether the decedents was not necessary for the Tax Court to consider whether the decedents retained the right to "possession or enjoyment of, or right to income from, retained the right to "possession or enjoyment of, or right to income from, the transferred property" under §2036(a)(1). the transferred property" under §2036(a)(1).

Estate of Bongard v. Estate of Bongard v. Commissioner,Commissioner, 124 T.C. No. 8 124 T.C. No. 8

(2005)(2005) FactsFacts

Decedent created an irrevocable trust in 1986Decedent created an irrevocable trust in 1986 Funded with some stock in his closely-held company, Funded with some stock in his closely-held company,

Empak. Empak. The trust made several distributions of stock to its The trust made several distributions of stock to its

beneficiaries between 1991 and 1994. beneficiaries between 1991 and 1994. Empak redeemed the stock as it was distributed, so that the Empak redeemed the stock as it was distributed, so that the

beneficiaries would have cashbeneficiaries would have cash As part of a plan to make Empak attractive for outside capital (a “corporate As part of a plan to make Empak attractive for outside capital (a “corporate

liquidity event”), the decedent formed a LLC on December 28, 1996.liquidity event”), the decedent formed a LLC on December 28, 1996. The decedent and the trust transferred all of their stock in Empak to the The decedent and the trust transferred all of their stock in Empak to the

LLC holding company.LLC holding company. The LLC had Class A units and Class B units.The LLC had Class A units and Class B units. There were Governing and Financial classes of the Class A and Class B units,There were Governing and Financial classes of the Class A and Class B units, Only the Class A units had voting rights.Only the Class A units had voting rights. Decedent’s son was chief manager subject to a “Member Control Decedent’s son was chief manager subject to a “Member Control

Agreement”Agreement”

Bongard – Cont’dBongard – Cont’d Member Control AgreementMember Control Agreement

Chief Manager was not granted sole decision making power over Chief Manager was not granted sole decision making power over allocation of distributionsallocation of distributions

Chief Manager power over accounting decisions limited if Class A Chief Manager power over accounting decisions limited if Class A disagreeddisagreed

2 Days later (on 12-30-96) Empak Directors were Changed2 Days later (on 12-30-96) Empak Directors were Changed Chief Manager did not vote on this although LLC was sole Empak Chief Manager did not vote on this although LLC was sole Empak

shareholdershareholder Decedent and Trustee of the 1986 Trust voted on thisDecedent and Trustee of the 1986 Trust voted on this

The next day (on 12-29-96), the decedent formed an FLP, The next day (on 12-29-96), the decedent formed an FLP, Transferred all of his Class B units in the LLC to it in exchange Transferred all of his Class B units in the LLC to it in exchange

for a 99% limited partnership interest.for a 99% limited partnership interest. The 1980 irrevocable trust transferred some of its Class B units The 1980 irrevocable trust transferred some of its Class B units

in the LLC to the FLP in exchange for a 1% general partnership in the LLC to the FLP in exchange for a 1% general partnership interest.interest.

This was part of decedent’s estate plan and not a necessary step This was part of decedent’s estate plan and not a necessary step in the business planin the business plan A gifting mechanism to family but without deterring them from A gifting mechanism to family but without deterring them from

working hard and becoming educatedworking hard and becoming educated Protection of estate from creditorsProtection of estate from creditors Greater flexibility than trustsGreater flexibility than trusts

Bongard – Cont’dBongard – Cont’d The decedent created a Children’s Trust and The decedent created a Children’s Trust and

Grandchildren’s Trusts in late December 1996.Grandchildren’s Trusts in late December 1996. He subsequently transferred enough of his Class A units in He subsequently transferred enough of his Class A units in

the LLC to those trusts so the LLC to those trusts so He held only a minority of the Class A units of the LLC.He held only a minority of the Class A units of the LLC.

About one year later (on 12-10-97), the decedent gave a About one year later (on 12-10-97), the decedent gave a 7.72% limited partnership interest in the FLP to his 7.72% limited partnership interest in the FLP to his wife.wife.

Less than one year later than that (on 11-6-98), the Less than one year later than that (on 11-6-98), the decedent died unexpectedly on a combined decedent died unexpectedly on a combined hunting/business trip to Austria.hunting/business trip to Austria.

IRS on ET Return AuditIRS on ET Return Audit $52M deficiency$52M deficiency EMPAK stock transferred to LLC included in D’s estate EMPAK stock transferred to LLC included in D’s estate

because D had retained rights in the stockbecause D had retained rights in the stock

Bongard – Cont’dBongard – Cont’d Court HoldingsCourt Holdings

Bona Fide Sale Exception Applies To Formation Of LLC.Bona Fide Sale Exception Applies To Formation Of LLC. Decedent’s transfer of his Empak stock to the LLC satisfied the Decedent’s transfer of his Empak stock to the LLC satisfied the

bona fide sale exception to §2036bona fide sale exception to §2036 the decedent possessed a legitimate and significant nontax reason for the decedent possessed a legitimate and significant nontax reason for

the transfer (i.e. part of the plan for the “liquidity event”)the transfer (i.e. part of the plan for the “liquidity event”) because he received LLC interests proportionate to the value of the because he received LLC interests proportionate to the value of the

property transferred to it.property transferred to it. Bona Fide Sale Exception Does Not Apply To Formation Of Bona Fide Sale Exception Does Not Apply To Formation Of

FLP.FLP. Decedent’s transfer of his LLC Class B units to the FLP did not Decedent’s transfer of his LLC Class B units to the FLP did not

satisfy the bona fide sale exception.satisfy the bona fide sale exception. No significant non-tax motive

No real continued gifting plan Holding company already provided protection from creditors No evidence that holding LP interest provided extra flexibility

than holding LLC ouright Implied Agreement For Retained Enjoyment Cause §2036(A)Implied Agreement For Retained Enjoyment Cause §2036(A)

(1) Inclusion For(1) Inclusion For FLP Assets.FLP Assets. An implied agreement existed whereby the decedent retained the An implied agreement existed whereby the decedent retained the

benefit of the LLC Stock transferred to the FLPbenefit of the LLC Stock transferred to the FLP

Bongard – Cont’dBongard – Cont’d Court found Decedent kept control:Court found Decedent kept control:

Decdnt controlled whether FLP could transform LLC stock into cashDecdnt controlled whether FLP could transform LLC stock into cash Decdnt as CEO and sole director of Empak controlled timing of stock redemptions for Decdnt as CEO and sole director of Empak controlled timing of stock redemptions for

cashcash He didn’t cause underlying Empak stock to be redeemed thereby assuring that FLP would He didn’t cause underlying Empak stock to be redeemed thereby assuring that FLP would

not engage in asset managementnot engage in asset management Dissent’s Attack on Section 2036(a)(1) Analysis.Dissent’s Attack on Section 2036(a)(1) Analysis.

A separate opinion points out alleged weaknesses of the majority’s §2036(a)(1) A separate opinion points out alleged weaknesses of the majority’s §2036(a)(1) analysis.analysis.

The opinion concurs as to the LLC issue, but dissents as to the FLP issue. The opinion concurs as to the LLC issue, but dissents as to the FLP issue. Only 3 of the 17 judges agree with dissent viewOnly 3 of the 17 judges agree with dissent view

it will tough in the future to defend against a §2036(a)(1) claim in the Tax it will tough in the future to defend against a §2036(a)(1) claim in the Tax Court if the bona fide sale for full consideration exception does not apply.Court if the bona fide sale for full consideration exception does not apply.

Seems like the case had good facts to defend against a §2036(a)(1) attack. Seems like the case had good facts to defend against a §2036(a)(1) attack. The court found an implied agreement giving the decedent continued The court found an implied agreement giving the decedent continued

enjoyment of the FLP assetsenjoyment of the FLP assets despite the fact that the decedent never received ANY benefits despite the fact that the decedent never received ANY benefits

whatsoever from the FLP for the balance of his lifetime,whatsoever from the FLP for the balance of his lifetime, indeed the court acknowledged that the decedent did not need the FLP indeed the court acknowledged that the decedent did not need the FLP

assets to maintain his standard of living.assets to maintain his standard of living. The only factorThe only factored to support the existence of an implied understanding ed to support the existence of an implied understanding

was the purported ability of the decedent to control cash flow to the was the purported ability of the decedent to control cash flow to the entity. entity.

Control over cash flow to the FLP does not logically lead to the Control over cash flow to the FLP does not logically lead to the existence of an implied understanding as to how the cash would be used existence of an implied understanding as to how the cash would be used once it reached the FLPonce it reached the FLP

Bongard – Cont’dBongard – Cont’d Application of Discounts.Application of Discounts.

The court’s decision that §2036 does not apply to the The court’s decision that §2036 does not apply to the creation of the LLC, and the refusal to bring back the creation of the LLC, and the refusal to bring back the underlying LLC assets (i.e., the Empak stock) into the underlying LLC assets (i.e., the Empak stock) into the estate means that discounts attributable to the LLC were estate means that discounts attributable to the LLC were allowed. allowed.

The parties stipulated that if §2036 did not apply to the The parties stipulated that if §2036 did not apply to the transfers to the LLC,transfers to the LLC,

a 13% lack of control discount a 13% lack of control discount and a 17.5% lack of marketability discount (or a seriatim and a 17.5% lack of marketability discount (or a seriatim

discount of 28.23%) would apply to the Class A units owned by discount of 28.23%) would apply to the Class A units owned by the decedent,the decedent,

and an additional 5 % lack of voting rights discount (for a total and an additional 5 % lack of voting rights discount (for a total seriatim discount of 31.82%) applied to decedent’s ownership seriatim discount of 31.82%) applied to decedent’s ownership of the Class B units in the LLC, that were directly owned or of the Class B units in the LLC, that were directly owned or that were included in decedent’s estate under §2036 as to the that were included in decedent’s estate under §2036 as to the FLP.FLP.

The LLC discounts generated a total reduction of the gross The LLC discounts generated a total reduction of the gross estate by almost $42.6 million.estate by almost $42.6 million.

FLP Planning FLP Planning ConsiderationsConsiderations

Existing FLP’s – It is likely crucial for Existing FLP’s – It is likely crucial for existing entities to consider existing entities to consider restructuringrestructuring Eliminate right of potential decedent to Eliminate right of potential decedent to

vote on liquidations and distributionsvote on liquidations and distributions Inter Vivos GiftInter Vivos Gift

But potential gift taxBut potential gift tax Also Sec 2035 would disregard if made within 3 years Also Sec 2035 would disregard if made within 3 years

of deathof death ReclassificationReclassification

Two classes Two classes One has all vote and liquidation rightsOne has all vote and liquidation rights Other class has no such rightsOther class has no such rights

FLP Planning FLP Planning Considerations (Cont’d)Considerations (Cont’d)

Amendment not produce gift because potential Amendment not produce gift because potential decedent owns all limited partnership interests and still decedent owns all limited partnership interests and still possesses all pre- amendment voting rightspossesses all pre- amendment voting rights

If the interest carrying voting rights was small If the interest carrying voting rights was small (e.g. .5% of FLP) then likely no gift tax will be produced(e.g. .5% of FLP) then likely no gift tax will be produced

Incomplete Gift TrustIncomplete Gift Trust Transfer the voting and liquidation rights to a trust Transfer the voting and liquidation rights to a trust

under which potential decedent has right to change under which potential decedent has right to change beneficiariesbeneficiaries

The theory is that retained modification would mean no The theory is that retained modification would mean no giftgift

However, as Trustee now has the rights potential However, as Trustee now has the rights potential decedent avoids inclusion of those rightsdecedent avoids inclusion of those rights

Property in trust still in estate – but subject to discountProperty in trust still in estate – but subject to discount


Section 2035 will generally defeat any of these Section 2035 will generally defeat any of these strategies if they occur within 3 year of deathstrategies if they occur within 3 year of death

But in case of sale for full consideration Section 2035 But in case of sale for full consideration Section 2035 bona fide sale exception might be useablebona fide sale exception might be useable

On account of valuation rules (i.e. the sale needs to On account of valuation rules (i.e. the sale needs to be for the value of corpus not just life estate which be for the value of corpus not just life estate which inflates the estate of the selling partner) this likely inflates the estate of the selling partner) this likely only works in context of sale to spouseonly works in context of sale to spouse

Example Example Ptr with 98% LP interest and virtually all of GP Ptr with 98% LP interest and virtually all of GP

with each carrying voting rights that would with each carrying voting rights that would trigger no-discount rules of trigger no-discount rules of Strangi Strangi and and BongardBongard

Assume P/P Assets worth $20M but have a Assume P/P Assets worth $20M but have a discounted value of $15M.discounted value of $15M.


Partner sells interests for discounted value of $15M Partner sells interests for discounted value of $15M (no gift)(no gift)

However, doesn’t work if death w/n 3 years as case However, doesn’t work if death w/n 3 years as case law requires sale be for full $20M for full law requires sale be for full $20M for full consideration exception to Sec. 2035 consideration exception to Sec. 2035

So, to meet the full consideration requirement of Sec So, to meet the full consideration requirement of Sec 2035 Partner would have to inflate his estate by $5M 2035 Partner would have to inflate his estate by $5M and receive a taxable gift of $5M from his purchaserand receive a taxable gift of $5M from his purchaser

If however, in the $20M scenario the purchaser is If however, in the $20M scenario the purchaser is the spouse of the partner there is no taxable gift, the spouse of the partner there is no taxable gift, and no Sec 2035 inclusionand no Sec 2035 inclusion

The selling partner’s estate is still inflated by $5 M The selling partner’s estate is still inflated by $5 M but the spouse estate is at the same time reduced by but the spouse estate is at the same time reduced by $5M which offsets and preserves the discount of the $5M which offsets and preserves the discount of the couple.couple.


FormationFormation For “Pooling of Interests” Bona Fide Sale For “Pooling of Interests” Bona Fide Sale

Exception to Sec. 2036 Exception to Sec. 2036 All family members contribute property to FLPAll family members contribute property to FLP Each receives a P/P interest equal in value to Each receives a P/P interest equal in value to

contributioncontribution Keep in MindKeep in Mind

Case law requires a “business purpose”Case law requires a “business purpose” Each contributing partner needs to use independent Each contributing partner needs to use independent

wealth (otherwise step transaction will be asserted by wealth (otherwise step transaction will be asserted by IRS)IRS)

Some concern that not all of potential decedent’s Some concern that not all of potential decedent’s contribution would be deemed by IRS as included in contribution would be deemed by IRS as included in his/her capital account – thus there is risk of a gifthis/her capital account – thus there is risk of a gift


Restriction on Voting RightsRestriction on Voting Rights The essential idea is for the potential decedent The essential idea is for the potential decedent

to not have voting rights re liquidations and to not have voting rights re liquidations and distributionsdistributions

This avoids Sec. 2035 as wellThis avoids Sec. 2035 as well Issues:Issues:

Gift on Formation – reduces value of what potential Gift on Formation – reduces value of what potential decedent receives back for his/stockdecedent receives back for his/stock

Some clients will balk at this lack of controlSome clients will balk at this lack of control VariationsVariations

Transfer of Control to Spouse Transfer of Control to Spouse Use of Incomplete Gift TrustUse of Incomplete Gift Trust


Other ConsiderationsOther Considerations Eliminate distributions to the Eliminate distributions to the

contributing potential decedent partnercontributing potential decedent partner Contributing potential decedent partner Contributing potential decedent partner

needs to maintain sufficient assets to needs to maintain sufficient assets to live on outside of the FLPlive on outside of the FLP

Personal use assets should not be Personal use assets should not be contributed (residences, cars)contributed (residences, cars)

Formalities must be observed – no Formalities must be observed – no conmingling of assetsconmingling of assets

Parting ThoughtsParting Thoughts

In FLP’s one size does not fit all – In FLP’s one size does not fit all – careful tailoring is requiredcareful tailoring is required

This is a dynamic area legally – This is a dynamic area legally – cases not totally consistent – many cases not totally consistent – many may still be appealed - stay alertmay still be appealed - stay alert

If when all is said and done, taxes If when all is said and done, taxes seem to be the only reason for the seem to be the only reason for the FLP, the Courts will strain to “do FLP, the Courts will strain to “do equity” and disallow the discountequity” and disallow the discount

Thank You!Thank You!

If You Have Further Questions If You Have Further Questions Contact:Contact:

Robert J. Kiggins, Esq.Robert J. Kiggins, Esq.

McCarthy FingarMcCarthy Fingar

Tel 914-946-3817 Ext. 251Tel 914-946-3817 Ext. 251

Email Email [email protected]@mfdds.com

Family Limited Partnerships By Robert J. Kiggins, Esq. of McCarthy Fingar, White Plains, NY...

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Transcript of Family Limited Partnerships By Robert J. Kiggins, Esq. of McCarthy Fingar, White Plains, NY...