May 2007
Volume 3, Number 1
Table of Contents

Summary Checklist For Family Limited Partnership Formation And Operations

By Byrle M. Abbin

A. Problems That are Created Upon Formation of Family Limited Partnerships

Delay in Funding: P/S Created Under Law Before Funding

  • Delay in Registering Partnership with State
  • Nearly 100% of Founder's Assets [including residence] Contributed
  • Aggressive Marketer [Fortress Group] Promoted FLPs, Provided Complete Packages, Including Legal Documents for a Flat Fee
  • Excessive Powers Over Operations, Distribution and Withdrawal are Retained
  • Documentation of Transfer of Assets to FLP Delayed
  • Simultaneous Transfers: FLP Formed and Gifts of FLP Units Made
  • Founder of FLP has Power to Control GP/Replace GP
    • Kimbell Circuit Court Rejected Implicit Control Doctrine
    • Bongard applied a "Practical Control" Test
  • FLP Formed When Founder was Very Old [95, 86, etc.] and/or Terminally III
  • P/S Agreement Powers Vitiate General Partner's Fiduciary Duty
  • There is a Lack of an Independent Trustee
  • P/S Assets and Management are not Segregated from Those Retained by Founder
  • FLP and/or Related Estate Planning Documents Indicate Founder's Financial Needs are Primary: Has First Call on All Income
  • Written/Oral Statements of Family Members Indicate Implied Agreement That All Income is Available to Creator
  • FLP is Funded by Generation 1Solely With Portfolio Assets
  • No Non-tax Reasons Evident or Stated For Partnership's Formation
  • No Business Activities are Conducted by the FLP (Portfolio Turnover, etc.)
  • Control Retained as CEO, Board Member of Business Place into FLP

 No Bona Fide Sale for Adequate and Full Consideration Took Place

• Second Tier Entity is not Required to Obtain Creditor Protection

B. FLP Operation--Actions Taken or Overlooked During Admininstration of Partnership

  • Required State Filings not Accomplished or Significantly Delayed
  • Separate Books and Records for P/S not Maintained
  • Separate Bank Accounts Not Maintained: Co-mingling of Assets
  • Lack of Recordation of Business Activities
  • Disproportionate Distributions are Made to Founding Partner
    • Especially to Meet Living Needs and Medical Expenses
  • FLP's Assets Managed by Outside Party, not the Partnership
  • Partner Redeemed Donee Charity Soon After FLP Formed
  • Indirect Control Provided to FLP Creator in P/S Agreement: so Control Not Given Up

  Once FLP Formed, no Donative Transfers are Made [Implies Estate Planning was Sole Motive]

  • P/S Administered Like a Trust, not a Business Entity
  • Lack of Regular Partner Meetings
  • Non Pro-rata Distributions to Partners [Based Upon/Related to Assets Transferred by Each Partner]
  • P/S K1s Misreported Identity of Partners [Ignored Intervening Trust]
  • Founder as Limited Partner Makes All/Most of Management Decisions
  • Fiduciary Responsibility of General Partner is not Relevant if FLP

  Does not function as an Operating Entity

C. "Big Picture Considerations: Often Involving Bad Perception

  (Another way to consider some of the problems noted above, sometimes alluded to as not passing the "smell test" and noted up front by the courts)

  • Low Wealth of Founder: Small Sized FLP Includes Personal Residence and/or Other Personal Property
  • Mass Marketer [Fortress Group] Promotes for a Flat Fee
  • Extreme Age and/or Sever III State of Founder
  • Unwinding of FLP Soon After Creator's Death [Implies Estate Planning]
  • P/S Formed by Agent [Under Power of Attorney] - Founder Uninvolved in the Process
  • Hard Copy Indicates Discount/Transfer Tax Savings Sole Purpose of P/S
  • Founders Illness Caused a 'Call' on all of P/S's Income
  • Family's Statements, Testimony Acknowledged 'G1 FLP Founder had Call' on all P/S Income
  • FLP's Assets Comprised Solely of Portfolio Securities
  • No Other Family Member Contributed to the P/S
  • Court Testimony of Family Member Exhibited Non-Informed About Details of Transaction and Evasive About Purpose of FLP

D. The "Good" Items to be Emphasized Upon Formation and During Partnership Administration

  • Regular Partnership Business Meetings
  • Recordation of Business and Non-tax Reasons for P/S
  • All Activities in Formation and Administration Done Orderly, in Proper Legal and Tax Sequence
  • Record Made of Contentious Family Relationships Between Parents and/or the Children as Reason and Need for Entity Wrapper
  • All Involved Family Generation Members Have Their Own Advisers
  • Lower Generations(s) Also Contribute Their Own Assets to P/S
  • Independent Evaluation by Financial Advisers/Accountants of Founder's Needs for Retainage, Determination of Amount
  • Contribution to P/S of Business Type Assets: Real Estate, Oil/Gas Working Interests

E. The Conflict in Court Determination of What Qualifies as a "Bona Fide Sale for Adequate and Full Consideration"

1. Kimbell

  • Arms length bargaining does not involve willing buyer/seller doctrine, but serious, businesslike intra-family negotiations
  • A bona fide sale is based upon objective factors at inception of the partnership
    • Each P/S contributor receives a property interest
    • Conclusory attitude [like Turner] on family transaction cannot be bona fide is rejected
  • De minimis contribution by other partners [G2, etc.] is recognized
  • Discounting of FLP interest does not connote lack of consideration, since entity provides future intangibles of value: management continuity, asset protection, buffer against intra-family friction and conflicts
  • Partnership is respected when 1) there is an asset contribution for a proportionate interest in the P/S, 2) such contribution is credited to a partner's capital account, and 3) upon dissolution/withdrawal, each partner is entitled to the value of her/his capital account

2. Turner

  • Bona Fide Sale not based upon willing buyer/seller but family deals are held to a 'higher' standard
    • There is no Bona Fide Sale if there is not business purpose and transaction is devoid of non-tax reasons [applies to portfolio partnerships]
    • Court rejects Kimbell definition and application; prefers subjectivity
  • Insufficient consideration is received for assets transferred to the FLP because of the entity discount
    • Yet, no front end gift resulted!!!
  • Arms' length willing buyer/seller standard is not required in establishing price, yet it is 'highly probative'
  • Value discount connotes a lack of adequate and full consideration to be a bona fide sale
    • Intangible benefits from the entity: asset management/continuity, asset protection, avoid family conflict from dissipating assets are irrelevant

3. Bongard

  • There are two elements--1) a bona fide sale, and 2) adequate and full considerations required to meet the exception to application of Sec. 2036(a)(1)

  "Bona fide sale" requires at least one significant non-tax reason

  • FLP creator must be financially independent of P/S, not depend upon P/S distributions

4. Strangi "IV"

  • To meet the exception to application of Sec. 2036(a)(1), both "prongs" of the test must be met: 1) a bona fide sale, and 2) adequate and full consideration
  • Adequate and full consideration is provided if there is proper partnership accounting for partners' capital contribution, distributions are charge proportionately to capital accounts,
  • diminution of value by receipt of partnership interest in formation of FLP is irrelevant
  • A bona fide sale requires that there be a significant non-tax reason for the partnership entity
  • The Tax Court's finding regarding the probity of non-tax reason(s) provided by the taxpayer controls, unless such conclusions are clearly erroneous. Even though the appeals court may have determined otherwise, generally it will not second guess the finding of fact by the Tax Court.

Copr. (C) 2006 West, a Thomson business. No claim to orig. U.S. govt. works. This article is reprinted with permission from West, a primary sponsor of the General Practice, Solo and Small Firm Division.

 

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