July 21, 2004 -- Family Limited Partnerships (FLPs), a popular estate-planning technique among wealthy families, recently gained an important victory over the Internal Revenue Service in a federal appeals court.  The victory comes in the wake of the May 2003 Estate of Albert Strangi case that led one lawyer to call family limited partnerships “dead in the water.”

FLPs are one of the key tools that accountants, lawyers and other financial advisers recommend to their wealthy clients to help reduce or even eliminate estate and gift taxes.  By transferring assets (such as cash, stocks, bonds or shares in a family-owned business) into a partnership formed with their children, wealthy individuals can transfer vast amounts of money and other property to their heirs virtually tax-free.

This strategy came into question after the Strangi case in which the IRS was successful in challenging the FLP arrangement, exposing Strangi’s heirs to a tax bill of more than $1 million.  In the case, the U.S. Tax Court ruled that Albert Strangi retained too much control over the key decisions of the partnership and was using the partnership assets as though he owned them outright.  As such, the Court found that Strangi didn’t actually make a gift during his lifetime, but retained his interest in the partnership assets.  As a result of this finding, the partnership property was pulled back into his estate for estate tax purposes.  Further compounding the misery, the Court held that no discount was permitted, making the entire value of the property taxable for estate tax purposes.

But a May 2004 decision in a separate case breathed new life into the FLP strategy as a three-judge panel ruled against the IRS.  The new decision involves the estate of Ruth A. Kimbell, who died in 1998.  At the time Mrs. Kimbell died, the value of the assets in the FLP was about $2.4 million.  When the federal estate-tax return was filed, the estate claimed a big discount on the value of Mrs. Kimbell’s interest in the partnership, to which the IRS objected.  Originally, the courts denied the discount, but the dispute landed in federal district court, and the Fifth Circuit reversed the district court’s ruling that had denied the estate’s request for a refund of the estate taxes and interest paid.

The Fifth Circuit panel noted that the assets contributed to the partnership included working interests in oil and gas properties, that Mrs. Kimbell retained sufficient assets outside the partnership for her own support, and that there was no commingling of partnership and Mrs. Kimbell’s personal assets.

Though the IRS may continue to fight FLPs in tax courts around the nation, the decision is viewed as a victory to those already involved in family limited partnerships or those considering such a strategy as a means of protecting their assets from estate taxes.

For more information, call an Asher professional at 215-564-1900.

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