Jun 1, 2010 12:00 PM

Beware of the whipsaw effect on an estate when a valuation discount of family limited partnership assets isn't respected in a decedent's gross estate

By N. Todd Angkatavanich

In the ongoing family limited partnership (FLP) battle between taxpayers and the Internal Revenue Service, taxpayers have been able to achieve some significant victories over the past two years in the Tax Court, particularly in the face of IRS challenges under Internal Revenue Code Section 2036(a). In these recent cases, the IRS has argued that all of the assets contributed by a decedent into an FLP during his lifetime should be included in the gross estate under a Section 2036(a) retained interest theory. Six recent cases, however, have demonstrated that it's possible for a taxpayer's estate to successfully defend a Section 2036(a) challenge by satisfying the “bona fide sale for an adequate and full consideration” exception to that statute.¹ These recent cases have been a positive indication that FLPs, if formed and administered correctly, are still viable estate-planning vehicles, and have clarified that the bona fide sale exception can be satisfied by showing that an FLP was created for “legitimate and significant non-tax reasons.”

However, two of the recent taxpayer victories also have a darker lining. In these cases, the IRS raised an issue revolving around a “marital deduction mismatch.” The IRS has raised this issue in the past and, most recently, in Estate of Black v. Commissioner and Estate of Shurtz v. Comm'r.² In both cases, the court found that the marital deduction mismatch issue was moot because the taxpayers' estates prevailed in convincing the Tax Court that Section 2036(a) didn't apply because the transfers into the FLPs satisfied the bona fide sale exception. Despite the victories achieved by the decedents' estates in these cases, they should, nonetheless, serve as a warning that this thorny issue exists and is currently on the IRS' radar in its challenge of FLPs. If the IRS' position is correct, there's a potential for unintended estate tax consequences that are often given little attention by estate practitioners when structuring and administering these vehicles.

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Topics of Interest

Estate Tax	Donor Advised Funds
GSTs	Family Offices
Private Foundations	Life Insurance
2010 Tax Act News	Industry Trends Surveys

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50 years ago, in May 1962, we featured articles such as: "Future of Canadian Trusteeship" by Arthur H. Mingay", "Training Trust Employees" by Ian M. Marr, "What is a Trust Officer?" by Eric J. Brown, and "Selling Services" by Donald I. Webb.

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