From WS+B’s Estate and Trust expert, newest partner, and all-around swell guy, Hal Terr:
In a recent case, Estate of Paul Liljestrand , TC Memo 2011-259 (Tax Ct.), the IRS was once again successful in its attack of Family Limited Partnerships (FLPs). The Tax Court found in favor of the IRS and concluded the value of the assets of the FLP was included in the gross estate under IRC Sec. 2036(a).
The case provides a list of actions that we have discussed in previous posts of what high net worth taxpayers should avoid when implementing a FLP:
- Management of the real estate owned by the decedent did not change from when the decedent owned the real estate in his revocable trust to when the real estate was owned by the FLP.
- Although the FLP created in 1997 and legal title of the real estate was transferred to the FLP, the income from the real estate was deposited in the revocable trust of the decedent.
- Partnership tax returns for the FLP were not filed until 1999. The income from the real estate was reported on the decedent’s individual income tax return in 1997 and 1998.
- Although the decedent made gifts of interests in the FLP to irrevocable trusts for the benefit of his children that exceeded the available annual exclusion, gift tax returns were not filed until after the decedent’s death.
- The decedent retained insufficient investments outside of the FLP to pay for his personal living expenses and used the income from the real estate in the FLP to pay for personal expenses.
- There were disproportionate distributions of cash flow to the decedent.
- And finally, the investments in the FLP were used to pay the estate tax of the decedent.
The Tax Court concluded that the FLP was “created principally as an alternate testamentary vehicle to the trust and that the decedent retained enjoyment of the contributed property within the meaning of IRC Section 2036(a).”
What can be learned from the case: When implementing a FLP, it is very important to document the non-tax reasons for formation. In addition, the FLP cannot be the personal piggy bank of the individual creating the FLP and the individual should only fund the FLP with investments not needed to meet personal expenses.