Matt Stelzman
The family limited partnership can be a powerful tool for consolidating and managing family wealth while reducing gift and estate taxes. Its tax-saving potential, however, makes it an attractive target for IRS attacks. Yet, despite repeated challenges over the years, the FLP remains a viable strategy.
Recent court cases demonstrate that a properly planned FLP — established for legitimate, nontax business purposes — can support substantial valuation discounts for transfer tax purposes. But if the parties are unable to provide a nontax reason for establishing an FLP, or fail to operate it as a legitimate partnership, these benefits may be lost.
Case in point
In Keller v. United States, the 5th U.S. Circuit Court of Appeals upheld 47.5% valuation discounts for FLP interests, even though the decedent’s estate plan was incomplete at the time of her death and she hadn’t yet funded the FLP.
After her husband’s death in 1999, the decedent, Maude Williams, worked with her advisors to explore options for protecting her family’s assets. Ultimately, she decided to form an FLP funded with $250 million in corporate bonds and certain other assets. The FLP would have two limited partners: Two trusts, each holding a 49.95% interest. An LLC initially owned by Williams would hold a 0.1% general partnership interest.
Williams died before she and her advisors had completed the documentation necessary to establish and fund the FLP. Believing it was too late to take advantage of the FLP’s benefits, her advisors arranged for her estate to pay more than $147 million in estate taxes. Later, after one of her advisors learned about promising new case law in an estate planning seminar, they reconsidered their position.
The estate filed a refund claim, arguing that under Texas law Williams’ intent to transfer the bonds to the FLP was sufficient to transform them into partnership property, despite her failure to complete all of the documents. In addition, because this transfer required the estate tax payment to be recharacterized as a loan from the FLP, the estate argued that it was entitled to an interest deduction.
The district court and, ultimately, the 5th Circuit, agreed with the estate, accepting its valuation of the FLP interests, with a 47.5% discount, as well as its interest deduction. The courts found that the FLP had legitimate non-tax purposes — including asset and divorce protection — and that the very thorough, detailed and well-documented planning efforts demonstrated Williams’ intent.
A look from the other side
Even if substantial valuation discounts are supportable, the tax benefits of those discounts can be lost through poor planning. That’s what happened in Estate of Liljestrand v. Commissioner. The decedent in that case properly formed an FLP but, according to the U.S. Tax Court, failed to follow “even the most basic of partnership formalities,” including maintaining books, holding meetings and keeping minutes. In addition, the decedent failed to open a bank account for the FLP until several years after it was formed, took disproportionate distributions, didn’t retain assets outside the FLP sufficient to support his lifestyle and used FLP assets to pay his personal expenses.
The court found that the decedent had retained possession or enjoyment of, or the right to the income from, the property transferred to the FLP and that his estate was unable to establish a legitimate, non-tax purpose for the FLP. As a result, the decedent’s asset transfers to the FLP were not bona fide sales. Therefore, the full, undiscounted value of the FLP assets were includible in the decedent’s estate.
Planning is critical
As these two cases demonstrate, thorough planning is key to making an FLP work and supporting valuation discounts. Depending on state law, a well-thought-out and documented plan can preserve an FLP’s benefits even if a client dies before the plan is fully executed. But even if an FLP is properly executed, an FLP can be undone, and its valuation discounts lost, through poor planning and operation.
Keller v. United States, No. 10-41311 (5th Cir. 9/25/2012)
Estate of Liljestrand v. Commissioner, T.C. Memo 2011-259 (11/09/2011)
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Matt Stelzman is an Accredited Valuation Analyst and Certified Forensic Financial Analyst designated by the National Association of Certified Valuation Analysts. Mr. Stelzman has over 10 years of experience in business valuation and litigation support services. He works in the Specialized Services Group of Henderson Hutcherson & McCullough, PLLC. For more information visit their website at www.hhmcpas.com or call Mr. Stelzman directly at 702-8147.