INTERPLAY OF BEHAVIORAL ECONOMICS AND PORTFOLIO MANAGEMENT WITH THE CURRENT EXAMINATION OF FAMILY PARTNERSHIPS BY THE COURTS, THE

Real Property, Probate and Trust Journal, Spring 2005 by Harrison, Louis S, Janiga, John M

5. "Accordingly, the existence of the partnership should be disregarded for estate tax valuation purposes."14

Thereafter, Field Service Advisory 200049003 listed a series of issues that the Service believed could be used to attack a FLP structure.15 These issues included section 2703, whether a restriction on liquidation requiring the consent of a certain percentage of voting interests could be disregarded under section 2704(b), the application of section 2704(b) to the conversion of transferred interests into assignee interests, whether section 2036 might apply to the assets the decedent contributed to the partnership, whether a gift on formation argument might apply, lapsing rights under section 2704(a), the lack of economic substance doctrine, and in the alternative to all the foregoing, whether the amount of a discount could be challenged.

These TAMs and part of the Field Service Advisory clearly assert the Service's position: investment FLPs should not be respected because they offer no real investment substance or purpose beyond tax savings. This position has led to considerable litigation.

B. Evolving Perception by the Courts

The holdings in the partnership cases in the last few years provide a roadmap of the permissible boundaries of, and concerns on the estate tax side with, investment FLPs. These cases provide an overview of what courts will and will not allow and a sense of the courts' attitude toward (and therefore strong influence on) planning in this area.

The following principles emerge from these cases.

1. The Good: Partnerships as an Entity Will Be Respected for Transfer Tax Purposes

The court enunciated the principle that an entity will be respected for transfer tax purposes in Church v. United States.16 Church involved a ranch that was contributed to a partnership. On October 22, 1993, two days before the decedent's death, a family partnership was established. The court, though skeptical, found that restructuring ownership interests to remove control from the decedent and her descendants constituted a sufficient business purpose to form the partnership. The court asserted that:

The character of the interests owning a majority of the Ranch changed dramatically as a result of the Partnership. Prior to its formation, [taxpayer] and their descendants would have owned undivided interests in the Ranch, with each interest carrying the right to use and enjoy the property, or force a partition or possible sale. The Partnership eliminated these individual rights and placed ownership of a majority of the Ranch in a Partnership that was not controlled by any single person.17

The court concluded: "I find as a matter of fact that the Partnership had bona fide business purposes and was not a sham as that term is used in estate taxation."18

The Tax Court's acceptance and support of the validity of partnerships as entities, regardless of tax or other motivation, was strongest in Estate of Strangi ("Strangi I").19 Strangi I involved a Texas limited partnership created about two months before the decedent died. The fair market value of the property contributed to the partnership was about $10 million, and the decedent owned a 99% limited interest. Stranco was a corporate general partner, of which the decedent owned a 47% interest and the decedent's four children owned the remaining 53% interest. The bottom line was that the decedent gave up control of the partnership even though he contributed over 99% of the equity value.20