Family Limited Partnerships: To Qualify or Not to Qualify for the Bona Fide Sale for Full and Adequate Consideration Exception Under §2036

The recent cases have looked at whether certain rules apply to FLPs, and how to avoid those rules. The focus is on a specific exception that allows for a genuine sale of property. This article will analyze those cases and discuss ways to plan to avoid the rules by meeting the exception. This exception is an important part of the law, and we will look at how it works in the context of FLPs. In Kimbell v. United States, the Fifth Circuit Court of Appeals ruled that the district court was wrong to deny the estate’s request for a refund of estate tax and interest paid. The court found that Mrs. Kimbell’s transfer of property to the FLP qualified for the bona fide sale exception, and that the transferred property was not includible in her estate. The court also discussed the requirements for a sale to be considered “bona fide” and cited other cases with similar transfers to FLPs. Ultimately, the court concluded that the transfer to the FLP was a genuine business transaction and not a disguised gift or sham transaction. The Fifth Circuit said that the district court didn’t consider all the evidence in favor of the taxpayer’s argument that the transfer to the FLP was for real business reasons, not just to avoid taxes. They pointed to things like Mrs. Kimbell keeping enough money outside of the FLP for personal expenses, following all the rules for forming the FLP, and having good reasons for making the FLP that couldn’t be done with her revocable trust. In another case, the Third Circuit said that if a transfer just looks like moving money around in a circle and doesn’t seem to be mostly for real business reasons, it won’t count as a true sale for tax purposes. They said that even though the FLPs did some business stuff, it wasn’t enough to count as a real business. The Third Circuit found that the activities conducted on behalf of the FLPs were not legitimate business operations. It was determined that the FLPs were not conducting valid business, and the transfers to the FLPs did not constitute bona fide sales. This means that the FLPs were not actually conducting business and the transfers of assets to the FLPs were not done in good faith. The court also noted that the assets transferred to the FLPs were mainly marketable securities, which further undermined the legitimacy of the business. The Fifth Circuit Court ruled that the assets Mr. Strangi transferred to the FLP should be included in his estate for tax purposes. The court said the transfer did not have a good business or non-tax reason and rejected the estate’s arguments for why Mr. Strangi made the transfer. Mr. Strangi’s estate argued that the Family Limited Partnership (FLP) was created to protect against potential lawsuits and disputes, but the Tax Court found that there was no clear evidence to support these claims. The court also rejected the argument that the FLP was formed as a joint investment vehicle, as it did not make any investments and had minimal contributions from the other partners. Overall, the court determined that the reasons given for creating the FLP were not valid. In the Kimbell case, the estate argued that the assets transferred to the FLP were mostly real estate, so the transfer was fair. But the court found that the FLP didn’t actually manage those assets, so the argument was rejected. In the case Estate of Bongard v. Commissioner, the court ruled that the transfer of stock to a limited liability company (LLC) was a legitimate and significant non-tax reason, but the transfer of membership interests in the LLC to a family limited partnership (FLP) did not meet the criteria. The court found that the reasons given for creating the FLP, such as making gifts and fulfilling post-marital agreement requirements, were not sufficient to justify the transfer. The ruling emphasized the importance of having a valid non-tax reason for creating such entities. Mr. Bongard formed a Family Limited Partnership (FLP) for asset protection and to teach his children about managing family assets. However, the court rejected these reasons because the FLP did not actually provide extra protection for the assets or help manage them. In another case, the court also found that a transfer of assets to an FLP was not done in good faith and did not have any non-tax benefits, so it was subject to certain tax rules. Mrs. Bigelow transferred property to a Family Limited Partnership (FLP) and continued to make gifts even though she couldn’t afford it. The transfer was not done properly and did not provide any non-tax benefits. In another case, the Korby family also transferred assets to an FLP, and the court determined that there was an agreement that the assets would still be available to them if they needed money. The court also found that the transfer was not a bona fide sale because Mr. Korby was involved in all aspects of the FLP and the fees paid from the FLP were not for management. In simple terms, the estate argued that they set up the FLP (Family Limited Partnership) to protect their family from business and personal problems. They pointed to the FLP agreement, which had rules to prevent partners from taking money out or transferring their share easily. But the Tax Court didn’t think these rules were enough to protect the family from creditors in case of a partner’s financial trouble. So, the court didn’t agree that the main reason for making the FLP was to protect the family’s money. Mr. Schutt transferred stock in two companies to family trusts to continue his family’s investment philosophy. The Tax Court ruled that this transfer met the bona fide sale exception, meaning it was a legitimate sale and not just a way to avoid taxes. The court also noted that others besides Mr. Schutt added assets to the trusts, showing that it was more than just moving his own assets around. This ruling gives a checklist for others to follow if they want to make similar transfers. Setting up a Family Limited Partnership (FLP) should have a good reason besides just saving on taxes. It could be for things like passing on wealth to younger family members, protecting assets from creditors, or managing investments. The FLP should actually be used for these reasons, like making real investments and having regular meetings with partners and advisors. If the FLP is involved in a real business, it’s more likely to be seen as a legitimate reason for setting it up. And if you’re trying to protect assets from creditors, make sure to put the assets that are at risk into the FLP separately from the ones that aren’t. 1) When creating a family limited partnership (FLP), each partner must put in assets based on their share.
2) If the FLP ends, partners should get back the money they put in.
3) Keep some money separate for personal expenses.
4) Don’t mix personal and FLP money.
5) Follow the rules for setting up the FLP and transfer assets correctly.
6) Consider working with non-family members to avoid problems. This article discusses cases involving family limited partnerships and their tax implications. The cases show that the IRS is cracking down on partnerships that are not set up for legitimate business reasons, but just to avoid taxes. It’s important to make sure that family limited partnerships are set up correctly and for valid business reasons in order to avoid problems with the IRS.

Source: https://www.floridabar.org/the-florida-bar-journal/family-limited-partnerships-to-qualify-or-not-to-qualify-for-the-bona-fide-sale-for-full-and-adequate-consideration-exception-under-2036/