Family limited partnership failure—lessons learned
TAX BLOG |
The U.S. Tax Court has restated the ground rules for what is required to use a family limited partnership to transfer wealth from an estate. The case is a reminder that intrafamily transfers need to be founded upon sound business reasons and respected accordingly.
In a recent case, an individual created a partnership. She also formed an LLC to serve as the general partner. She contributed marketable securities to the partnership, both "on behalf of" the LLC, which took a 0.1 percent general partner (GP) interest, and in exchange for a 99.9 percent limited partner (LP) interest for herself. She then transferred the GP interest to her children in exchange for cash equal to the gross value of that interest and transferred a 10 percent LP interest to an irrevocable trust that she had created contemporaneously.
The partnership agreement provided that income in excess of operating costs would be distributed to the partners, though there was only one small distribution made before the individual died. The estate reported only the decedent’s remaining 89.9 percent LP interest on the decedent’s estate tax return.
The IRS argued for inclusion of all partnership assets in her estate on the basis that the transfers in question were not bona fide sales.
The court agreed, finding no significant nontax purpose for the formation of the partnership, no respect for the partnership’s business or operational structure, and no other indicators of anything other than an estate tax motivated transaction. Indeed, at the end of the day, as the IRS asserted, the decedent was on the same side of the transaction in the sense that she effectively controlled the assets both before and after the transaction.