Family limited partnerships (FLP) are often proposed by estate planning advisors as a vehicle for making gifts to family members at a discount. Over the years, a substantial amount of litigation has established some limits for a valid family partnership entity. In Estate of Jorgensen v. Comm'r, T.C. Memo 2009-66 (T.C. 2009), the Tax Court ruled that the value of transfers made to family members from two family limited partnerships during the decedent's life should be included in the decedent's gross estate. In this Emerging Issues Analysis, Kathleen Sablone discusses Jorgensen and examines its effect on estate planning with family limited partnerships. She writes:
The IRS initially relied on sections 2701-2704 to argue that FLP entities were shams and that restrictions in the partnership agreements should be disregarded for valuation purposes. The courts repeatedly rejected this line of attack on the grounds that it was beyond the scope of those code sections. Eventually, the IRS tried a new approach--§2036 of the Internal Revenue Code. Section 2036 provides that property transferred during life must be included in the gross estate if the decedent retains (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom. This section does not apply to a bona fide sale for full and adequate consideration.
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Initially, it appeared that IRS victories under section 2036 were limited to cases with fact patterns involving egregious taxpayer behavior. Over time, however, the reach of section 2036 has been extended. Jorgensen is the latest in a string of FLP cases successfully litigated by the IRS using section 2036.
Although Jorgensen does contain some unfavorable facts, the taxpayer did attempt to follow some of the rules set out in prior cases. For example, the partnership was not formed on Mrs. Jorgensen's deathbed and she retained sufficient assets to pay her living expenses. The FLPs in this case were also fairly typical of many FLPs used in estate plans in that they held passive investments in marketable securities. What does Jorgensen mean for the future of the FLP as an estate planning technique? It should be a warning that an FLP is not a one size fits all planning tool and should not be overused. If a client is unsophisticated and unlikely to pay attention to operational details, then an FLP may pose a considerable risk.
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