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

Xxx An analogous argument can be made when an individual is the substantial contributor of capital to a FLP but does not retain control. Suppose that the father contributes 99% of the capital to a FLP in exchange for limited partnership interests representing 99% of the FLP. The remaining 1% is represented by general partnership interests. That 1%, because it represents control, is worth more than 1% of the value of the FLP. Consequently, by not retaining the general partnership interest, the father retains less than the 99% he contributed, resulting in some gift on formation value.28

3. The Ugly: A Partnership that Does Not Have a Purpose Other than Estate Tax Discounts is Disregarded Because of Code section 2036

In broad terms, paragraphs (1) and (2) of section 2036(a) apply if the decedent has transferred property but retained beneficial interests or control over others' interests.29 However, transfers that are a "bona fide sale for an adequate and full consideration in money or money's worth" are exempt from section 2036's reach.30 Although a transfer of assets to a FLP arguably constitutes adequate and full consideration, the Service generally has rejected this position. In three key cases-Strangi II,31 Kimbell II,32 and Thompson33-the Service has argued that section 2036 should apply to include the FLP assets in the decedent's gross estate, thereby disrespecting the FLP itself (meaning no discounts).

Taken together, these three cases have established the proposition that a partnership needs to be structured for more than just estate tax discounts in order for transfers to it to qualify for the bona fide sale for adequate and full consideration exception and thus to avoid section 2036 (or, stated another way, for the partnership to be respected for estate tax discounting). How far along this spectrum of economic reality the partnership needs to be is not quite certain, as the courts have not been clear on the standard.

The first case to evidence this strong proposition was in the second Tax Court review of the Strangi case, Strangi II.34 In Strangi II the court accepted both prongs of section 2036 (either one of which, by itself, would have been successful) to include the entire partnership in the decedent's gross estate. Using circuitous reasoning, the court invoked the first prong by concluding that the decedent, both directly and indirectly (via the decedent's agent acting for him), as a shareholder in the corporate general partner, had the right to distribute income to the partners, and therefore, as a limited partner, the decedent had retained the right to the income from the property.35 The court implicated the second prong by concluding that control as a general partner was tantamount to the "right to designate."36

The court then turned to the issue of whether the bona fide sale for adequate and full consideration exception applied. In doing so, the court stated that the exception rested on meeting two requirements: "(1) A bona fide sale, meaning an arm's-length transaction, and (2) adequate and full consideration."37 The court concluded that neither were met. On the first requirement, the court noted that the lack of meaningful negotiation or bargaining with the other anticipated interest holders meant that "decedent essentially stood on both sides of the transaction."38 On the second, the court noted that adequate and full consideration was not present if "there ha[d] been merely a 'recycling' of value through [a] partnership. . . ."39