Court
Ruling Bolsters Estate-Planning Tool
© The Wall Street
Journal
An embattled estate planning strategy just scored
an important victory.
The strategy, known as a family limited partnership,
has been under a cloud since a U.S. Tax Court judge ruled against
as partnership last year, exposing heirs to a tax bill of more than
$1 million.
But a new decision in a separate case is calming
fears about the popular technique that many wealthy families have
used to escape taxes. Las week, a federal appeals court threw out
a ruling against a different family partnership, dismissing the
Internal Revenue Service’s objections in that case. Lawyers
say that decision offers helpful guideposts for setting up structures
that will withstand scrutiny. Family partnerships have proliferated
during the last decade, allowing many wealthy people to transfer
large amounts of money and other property virtually tax-free to
heirs.
The latest decision should “certainly increase
the comfort level for the majority of taxpayers who would consider,
or have already utilized, a family limited partnership,” says
Charles R. Cangro, a partner at Ernst & Young.
While it isn’t clear how many of these partnerships
exist, lawyers and accountants say billions of dollars are at stake.
Family limited partnerships, or FLPs, are one of the key tools that
accountants, lawyers and other financial advisers recommend to wealthy
clients.
Concern about the technique grew last year after
the RS won a case involving the late Albert Strangi, a Texas businessman.
In essence, the judge said Mr. Strangi retained too much control
over his family partnership.
That decision jolted tax experts around the nation,
and is being appealed to the Fifth U.S. Circuit Court of Appeals.
It caused some people to either restructure or even unwind their
partnerships, lawyers say. In the wake of the Strangi decision,
one lawyer called the family partnerships “largely dead in
the water”.
A new decision in a separate case, handed down last
week by a three-judge panel of the same fifth-circuit appeals court,
has revived enthusiasm for the family partnerships. Lawyers sat
the basic message of the new ruling is that this technique is still
alive and well, and the panic about last years’ Strangi decision
appears to have been overblown. But they also stress that people
still need to be careful about key aspects of setting up these partnerships.
It’s an “important decision” says
Blanche Lark Christerson, of Deutsche Bank Private Wealth Management
in New York. “Basically, I see this as a lesson to the government
not to overreach in its arguments.”
A family partnership can help slash estate gift
taxes by transferring assets owned by a wealthy person into a partnership,
typically formed with children. For example, a parent could move
property – such as cash, stocks, bonds or shares in a family-owned-business
– into a partnership. In some cases, a parent can become the
general partner, with the kids as limited partners. In other cases,
a child serves as the general partner.
For the well-to-do, tax planning is crucial because
taxes can take an enormous bite out of what is left to heirs. This
year, the top federal estate-tax rate is 48%. The first $1.5 million
of a taxable estate is typically exempt from federal estate tax.
Under current law, the federal estate tax is scheduled
to be phased out in stages in coming years and then disappear entirely
in the year 2010 – but then reappear the following year.
The new decision involves the estate of Ruth A.
Kimbell, who died in March 1998 at the age of 96. The court threw
out a district court-ruling that had denied the executor’s
request for a refund of estate taxes and interest paid by the estate.
The case was sent back to the lower court.
The IRS declined to comment yesterday on the new
case but isn’t likely to surrender. In fact, the IRS may well
continue to fight FLPs in other circuits around the nation, according
to RUA, a New York publisher of tax and other business information.
At the time Mrs. Kimbell died, the value of the
assets in the family partnership – which was created, only
a few months before her death – was about $2.4 million. When
the federal estate-tax return was files, the estate claimed a big
discount on the value of Mrs. Kimbell’s interest in the partnership.
The three-judge panel noted that assets contributed
to the partnership included working interests on oil and gas properties.
The judges also noted that Mrs. Kimbell retained sufficient assets
outside the partnership for her own support, and there was no commingling”
of her partnership and her personal assets.
The Kimbell decision is “very helpful”
to many people with family limited partnerships or considering getting
into one, says Joshua Rubenstein, a New York lawyer at the firm
KMZ Rosenman. He says that well-structured FLPs “still retain
a very important place” in an arsenal of estate-planning techniques.
If the appeals court had affirmed the Kimbell ruling, “it
would have been a major victory for the IRS,” says Avram Salkin,
a tax lawyer in Beverly Hills, California. Instead, the decision
“confirms that carefully drawn agreements are still very much
alive.”
