PASSING DOWN A FAMILY OWNED waste management business with a popular, but controversial, estate planning tool seems to be more viable than ever, thanks to a ruling by a federal appeals court.
The device, known as a family limited partnership (FLP), is designed to minimize federal estate and gift taxes by taking assets that ordinarily would be included in an estate and shifting them to a partnership. After exempting the first $1.5 million from taxation, the graduated federal estate tax ladder tops out at 48 percent for 2004. Many wealthy individuals have achieved nearly tax-free transfers of vast sums of money and valuable property to their heirs. The strategy seemed workable and legitimate until early this year, when a U.S. Tax Court judge struck down a family partnership created by a Texas businessman whose heirs then were obliged to pay federal estate taxes totaling about $2 million. [See related story “All in the Family,” Waste Age, Feb. 2004, p.26]
Although the ruling was promptly appealed to the U.S. Court of Appeals for the Fifth Circuit, nervous estate planners and lawyers around the country immediately began notifying clients and restructuring partnership documents to eliminate questionable features.
These experts are now somewhat more relaxed — indeed, even enthusiastic — when advising clients about this popular tool. In mid-May, a three-judge panel of the Fifth Circuit disregarded Internal Revenue Service (IRS) objections and overturned a federal district court ruling against another Texas family partnership. The ruling denied the executor's request for a refund of estate taxes and interest. The appellate court held that family members can enter into a bona fide transaction and that a transfer of assets in return for a pro rata partnership interest can qualify as a transfer for adequate and full consideration. Notably, the court indicated that a transaction between family members will be scrutinized more thoroughly to assure that the arrangement is not a sham transaction or a disguised gift.
The appeals court decision is particularly helpful to lawyers, accountants and other financial advisors in identifying key aspects and elements that must be present for the arrangements to survive strict scrutiny.
The decision is “very helpful” to people who already have established FLPs or are considering them, New York lawyer Joshua Rubenstein told The Wall Street Journal. Well-structured FLPs “still retain a very important place” among estate planning strategies, he added.
For its part, the IRS, which initially declined to comment on the appeals court decision, shows no sign of acquiescing to what it considers to be an instrument created solely to dodge taxes. Tax lawyers and other estate planning experts expect the IRS to vigorously attack these devices in other circuits.
[Kimbell v. U.S., 371 F.3d 257 (5th Cir. 2004)]