Last March, Mirowski v. Commissioner, the U.S. Tax Court delivered a long-awaited victory to taxpayers and their appraisers when it found that a family limited partnership (FLP)—formed just days before the founder’s death—had legitimate, non-tax business purposes, sufficient to meet the exceptions under IRC Sec. 2036 and withstand an IRS attack.  Key to the court’s ruling: 1) no one expected the founder to die so quickly; 2) there was no provision to use the FLP assets to pay estate or gift tax liabilities (even though the latter were significant).  

Would the Astelford, Holman and Gross FLPs withstand a similar attack?  In recent weeks, we’ve also covered two gift tax cases, Holman v. Commissioner (May 2008) and Gross v. Commissioner (Sept. 2008), in which the formation and funding of FLPs withstood attacks by the IRS as indirect gifts.  In a third case, Astleford v. Commissioner (May 2008), the taxpayer convinced the court to adopt significant, multi-level discounts for lack of marketability and control in valuing the FLP.  Given the IRS’s sustained efforts to disable FLPs as tax-planning devices, however, the Service may likely attack these FLPs when their founders die, to recover the full value of the assets under Sec. 2036. 

What planning pointers can taxpayers glean from Mirowskito ensure more FLP victories in the estate context? That’s the very question Steve Akers of Dallas’ Bessemer Trust Co., NA, addresses in his current article, “Family Limited Partnership Planning Update in Light of Three Recent Judicial Decisions,” published in the Autumn 2008 Insights, by Willamette Management Associates:

Before getting carried away with the favorable taxpayer result in Mirowski, observe that Section 2036 involves a ‘smell test’ and Judge Chiechi (who wrote this judicial opinion) did not believe that the family was just forming the LLC to generate estate tax discounts.  The only way to rationalize the various FLP/LLC Section 2036 cases is to recognize that the courts apply a ‘smell test’ to avoid allowing a valuation discount in what the Tax Court perceives as abusive cases involving paper shuffling (often immediately before death) just to generate a valuation discount.

What helped Mirowski estate pass the “smell test,” Akers says, is the daughters’ credible testimony that their mother established the FLP for the significant non-tax reasons and not just to get the valuation discounts.   “Whether other judges will agree with that approach is yet to be seen.”  Cautious planners will continue to “be sensitive” about having the FLP founder serve as sole general partner or manager, Akers says, and they should pay attention to distributions—especially post-mortem payment of tax liabilities.  Finally, operating the FLP “in a way that is consistent with the stated nontax reasons” could be a deciding factor. 

Akers’ article is one of several in the current Insights, focusing on “Gift and Estate Tax and Intergenerational Wealth Transfers.” Archived articles will be posted to BVResearch™, which now boasts over 265 articles from Insights, 60 from Mercer Capital’s Value Matters, and more.