This month's FaxAlert highlights the findings of the Strangi 4 FLP case. This is the second appeal to the 5th Circuit. The opinion is a partial victory for the IRS, but the key points of the case are the issues regarding implied agreements (and use of FLP assets to pay estate administration expenses, debts of the decedent and estate taxes) and what is business and non-business purposes are sufficient to meet the "bona fide transfer for fair value" exceptio under IRC 2036.

On July 18, 2005, the Fifth Circuit released its long awaited opinion for the Strangi Family Limited Partnership (“FLP”) case. This is one of several key FLP cases in which the IRS has achieved victories over taxpayers by applying the retained possession or enjoyment and control provision of § 2036 of the Internal Revenue Code.

Albert Strangi, through his son-in-law acting as his agent under his power of attorney, contributed nearly $10 million in assets to a Family Limited Partnership. Albert was terminally ill at the time the FLP was formed and he died a short time later. The partnership held nearly 98% of Albert’s assets, including his residence and other real estate and nearly $7.5 million in marketable securities.

Albert paid no rent to continue to reside in his residence between the creation of the FLP and his death. Rent was accrued at a fair rate but not paid by the estate until more than two years after Albert’s death. He received distributions of $8,000 and $6,000 from the partnership “to meet his needs and expenses.” After his death, the FLP distributed to Albert’s estate over $100,000 to pay funeral expenses, administrative expenses, and a specific devise under Albert’s Will. The FLP also distributed almost $3.2 million to pay estate and inheritance taxes.

In its holding, the Fifth Circuit stated that “the controlling question is not whether Albert actually kept any assets in his possession, but whether he received a general assurance that his assets would be available to meet his personal needs.” The court further held that “part of the ‘possession and enjoyment’ of one’s assets is the assurance that they will be available to pay various debts and expenses upon one’s death.”

This is an expansion of earlier cases in which courts have indicated that it would be possible to find an “implied agreement” where the taxpayer failed to retain sufficient assets outside of a Family Limited Partnership to provide support for the taxpayer over his remaining lifetime. Here, the Fifth Circuit has included in the amount that should be retained by the taxpayer outside the FLP an amount sufficient to cover reasonably foreseeable personal debts and estate expenses, including funeral expenses, administrative expenses and possibly even estate taxes.

An exception to the application of IRC § 2036 is a bona fide sale. The Tax Court and Circuit Courts have expressed differences in opinions as to what is necessary to satisfy this exception. In this case, the Fifth Circuit held that a sale is “bona fide” if, as an objective matter, it serves “a substantial business or non-tax purpose.” In this case, the FLP consisted primarily of securities and real estate. In reviewing the opinion below, the Court found that there was no evidence of “clear error” with regard to the Tax Court’s express skepticism of the purported non-tax reasons offered by the taxpayer in forming this Family Limited Partnership, especially in light of its deathbed context.

The Court’s holding seems to indicate that both business and non-tax purposes will not be required to satisfy the “bona fide sale” exception to IRC § 2036. While it appears from the opinion that business purpose would not be required, a purpose involving an active business would obviously be highly probative. Where the taxpayer is relying on non-business purposes such as consolidation of management, ease of administration, reduction of administrative expenses and asset protection and other reasons, there would need to be substantial evidence of the actual existence of these benefits. Of course, where the taxpayer dies a short time after the formation of the partnership, it is much more difficult to overcome a presumption that the FLP was being formed solely to reduce estate taxes.

Although Strangi, Kimbell, Thompson, Abraham, Bongard and other recent FLP cases have shed light regarding retention of possession or enjoyment, “implied agreements,” and what constitutes a “bona fide sale” that places a transaction outside of the application of IRC § 2036, this is still an area of developing law. Despite the uncertainties, Family Limited Partnerships and Family Limited Liability Companies remain viable estate planning and asset protection vehicles for taxpayers with the right mix of assets and family circumstances. New FLP and FLLC Agreements have been developed that use Administrative General Partners, Managing General Partners, Voting Limited Partners, and Non-Voting Limited Partners to escape the application of IRC § 2036. Existing FLPs and FLLCs may need to be amended to incorporate these new features. This requires sophisticated planning with a law firm that focuses on the field of estate planning. Our law firm has such experience. If you are seeking assistance with advanced estate planning for your wealthier clients or a review of an exiting estate plan involving FLPs or FLLCs, contact us to schedule an appointment to speak with one of our attorneys.