Forming a foolproof family limited partnership is as easy as calling the most prestigious law firm in town and handing over the reins to them, right? The Turner family found out the hard way that even the best firms are prone to pulling an FLP off the shelf and using it with little modification. That approach may work for a simple will, but a strong FLP must be custom-built from the ground up or you risk having the IRS or a court set it aside. [Estate of Turner v. Commissioner, T.C. Memo. 2011-209 (2011)]
Clyde Turner Sr. and his wife, Jewell, acquired 170,000 shares of regions bank stock throughout their marriage. Because of family associations with the bank and sentimental attachment, they rarely sold shares in the bank.
Despite the Turners’ significant wealth and advancing age, they did not have a solid estate plan or even investment plan. As a result, their son Marc stepped in and tried to help Clyde Sr. get his estate plan in order. As part of that plan, Clyde Sr.’s estate planning attorney drafted a family limited partnership to hold the Turners’ significant stock holdings (and cash). The FLP, Turner & Co., was formed as a Georgia limited liability partnership. Under the partnership agreement, Clyde Sr. and Jewell each owned a 0.5% general partnership interest and a 49.5% limited partnership interest.
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About eight months after the FLP was formed, the Turners contributed assets with a total fair market value of $8,667,342 to the FLP. Transfers to the FLP were completed by December 2002.
Most of the value contributed to the partnership was made up of cash and marketable bank stocks, including shares of Regions Bank stock, shares of NBOG Bancorp stock, shares of Friends Bank, shares of Southern Heritage Bancorp stock, 21 CDs at Habersham Bank, and other assorted bank accounts and securities accounts.
The Turners received partnership interests in exchange for the contributions that were proportionate to the fair market value of the contributed assets (which the IRS stipulated to). The assets were properly titled to Turner & Co.
The Partnership Agreement
The partnership agreement, provided that the three general purposes of Turner & Co. were to “(1) To make a profit, (2) to increase the family’s wealth, and (3) to provide a means whereby family members can become more knowledgeable about the management and preservation of the family’s assets.” Nine specific purposes were also listed.
Because the partnership agreement was modeled on a standard used by the law firm, it included some provisions that did not apply to the Turner’s particular situation. Regardless, the partnership agreement still required that, “The General Partner shall effectuate the purposes of the Partnership and operated in accordance with the purposes of the Partnership and in accordance with the fiduciary duties, and the rights and powers granted it in this Agreement.”
In April 2002, Clyde Sr. and Jewell entered into a management fee agreement for the FLP. The Turners allocated $500 per month each to their sons, Mark and Travis, in exchange for daily management services. Payments were made to Mark and Travis, between 2002 and 2004.
Between 2002 and 2004, the FLP sold and bought a small amount of stock and also made two real estate purchases. As part of one of those purchases, the FLP incurred indebtedness to a bank. Shortly thereafter, Clyde Sr. paid the FLP’s outstanding debt. With respect to the other property, the FLP was unable to get a loan, so Clyde Sr. wrote a personal check at closing for $363,188.
On Dec. 31, 2002 and Jan. 1, 2003 the Turners gave limited partnership interest in the FLP to their three children and two of Joyce’s children. The total fair market value of the partnership interest transferred on Dec. 31, 2002 was $1,652,315 and the value of the partnership interest transferred on Jan. 1, 2003 was $474,315.
Clyde Sr. died on Feb. 4, 2004 and his estate filed a gift tax return on Oct. 13, 2004.
The IRS challenged the estate’s characterization of the FLP assets as being outside the estate. The estate challenged the IRS’ determination in the Tax Court.
The Tax Court’s Decision
A decedent’s gross estate includes the value of any interest in property held by the decedent at the time of his or her death. Specifically, Section 2036(a) includes the value of property in a decedent’s gross estate where the decedent had transferred property to another, but retained a life estate in the property. But property will not be included in the gross estate under that section if the property was transferred in a bona fide sale for adequate and full consideration.
A transfer to an FLP may be challenged under Section 2036(a) if the IRS believes that the taxpayer (or decedent) made the transfer but continued to use the property as they had prior to the transfer. When transfers are made to a family limited partnership, the general rule is that the taxpayer must establish a “legitimate and significant nontax reason” for the transfer. The motivation must be “actual motivation, not a theoretical justification.”