Appeals Court Supports IRS On Estate Tax Planning

by Leroy Baker, Tax-News.com, New York

21 July 2005

A US appeals court has dealt a blow to a popular estate tax planning technique used by wealthy families to mitigate the impact of inheritance tax.

In a decision posted earlier this week, the US Court of Appeals for the Fifth Circuit agreed with the Internal Revenue Service in a case involving the tax treatment of a family limited partnership.

In a typical family limited partnership, a parent transfers business or investment assets, such as a family business or real estate, to a partnership formed with his or her children. Most of the shares in the partnerships are transferred to the children, with the parents retaining a small ownership stake. It is argued that by transferring assets into a partnership, these assets become much harder to sell and therefore are worth much less.

However, in many cases parents assume the role of a general partner, meaning that they can still make management decisions about the assets while the children assume the title of limited partners, with less control. The net effect of this combination is that the parents still retain control over the assets whilst making a significant saving in estate tax.

The latest ruling was centred on a case involving a now deceased Texan businessman named Albert Strangi. According to the appeal court, although Mr Strangi had technically transferred his assets to the partnership, he effectively retained ownership. The court cited one example where Mr Strangi continued to live in a house which he had transferred to the partnership, although the partnership did not receive rent until after Mr Strangi had died. In the eyes of the court, this amounted to an "implicit understanding" that Mr Strangi would continue to benefit from the assets after they were transferred into the partnership. The court also reasoned that the partnership itself had no "substantial" reason to exist other than to avoid tax.

Although the ruling was intended to clarify the issue of family partnerships, many layers and tax planners contend that the decision has merely created more uncertainty.

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