This Tax Court decision provides another Section 2036 victory for the taxpayer by holding that assets transferred to an FLP were not includible in the decedent’s gross estate under Section 2036(a) because the transfer was a bona fide sale for adequate and full consideration. This case is particularly taxpayer friendly because the Tax Court focused on the non-tax purposes for forming the FLP and was able to overcome several bad facts.

The Decedent, Mrs. Shurtz, died in California in 2002. She was survived by her husband and children. The Decedent and her siblings grew up in Mississippi where their family owned and operated a timberland business.

By 1993, many family members held separate interests in the business. On the advice of counsel, the family formed a limited partnership, Timberlands LP, to manage and operate the business. A corporation was formed which owned a 2% GP interest in Timberlands LP. The Decedent and her two siblings each owned one-third of the stock of the GP and the Decedent owned a 16% LP interest.

After Timberlands LP was formed, the Decedent and her siblings raised concerns about protecting the family business from “Jackpot Justice” in Mississippi. They were concerned that they could be sued and a judgment entered against them and they could lose control of the business. To avoid this problem, their attorney recommended that each family hold its Timberland LP interest in a separate limited partnership. This recommendation was followed so that the active timber business was held in Timberland LP and the equity ownership was held in several new FLPs, one of which the FLP created by the Decedent.

The Decedent also wanted to give her children and grandchildren interests in 750 acres of timberland that she acquired from her parents.

In 1996, The Decedent and her husband formed an FLP. The purposes of the FLP were (1) to reduce the estate (2) provide asset protection and (3) provide for heirs. The Decedent transferred a 6.6% interest in the 750 acres to her husband who in turn received a 1% GP interest in the FLP. The Decedent contributed the balance of her interest in the 750 acres and her 16% LP interest to the FLP for a 1% GP interest and a 98% LP interest in the FLP.

The FLP agreement had substantial restrictions designed to keep persons outside the family from acquiring interests in the FLP.

Between 1996-2000, the Decedent made 26 gifts of .4% LP interests to her children and grandchildren. When the Decedent died in 2002, she held a 1% GP interest and a 87.6% LP interest in the FLP.

The IRS contended that the value of the assets the Decedent contributed to the FLP were includible in the value of her gross estate under Section 2036.

The “bad facts” in this case included the following: (1) the FLP did not maintain books of account as specifically required in the partnership agreement; (2) the partnership bank account was not set up until almost four months after formation of the FLP, and after two months as a checking account, it was changed into a money market account; (3) the Decedent and her husband paid some of the FLP’s expenses from their personal bank accounts, being reimbursed by the FLP for some payments and having others credited to their capital accounts; and (4) there were not always proportional distributions from the FLP to its partners.

The Tax Court reviewed the management style and operations of the LPs and the Judge noted that the entire family was conscientious about managing the family timber business, had a mission statement and held annual meetings in Mississippi.

The Tax Court found that transfer to the FLP was a bona fide sale because protecting the assets from potential litigants and using the FLP to facilitate the active management of the assets were legitimate and significant non-tax reasons for its creation. The Court acknowledged that reducing the estate tax was a motivating factor, but went on to say there were valid and significant non-tax reasons for establishing the partnership – therefore, the bona fide sale element was satisfied.

The Court found that the Decedent received an interest in the FLP that represented adequate and full consideration because (1) the participants in the FLP received interests proportionate to the value of the property each contributed; (2) the respective contributed assets were properly credited to the transferors’ capital accounts; (3) distributions required negative adjustments to distributee capital accounts; and (4) there was a legitimate and non-tax reason for forming the FLP. Therefore, the FMV value of the Decedent’s interest in the FLP, rather than the FMV of the assets she contributed to the FLP was includible in her estate.

Since the Tax Court found that a bona fide sale for adequate and full consideration occurred, the FMV of the property the Decedent contributed to the FLP was not includible in her gross estate under Section 2036.