Legal Lines

Tax Court Sides with FLP

The IRS has lost a recent battle involving a family limited partnership (FLP). In this case (Church Est. v. U.S., No. SA-97-CA-0774-OG (W.D. Tex. 1/18/00), the decedent and her children owned 57% of a ranch, and they all contributed their undivided interests to their FLP. The decedent also contributed $1 million in securities. The profit and loss from the ranch operation were to be allocated to each partner in proportion to his or her contribution. In addition, 99% of the income from the securities was specifically allocated to the decedent.

Two days after the FLP was formed, the decedent died unexpectedly. The estate discounted her limited partnership interests in the FLP, but the IRS rejected the valuation of the interests as reported on her estate tax return.

Before a federal district court, the IRS contended that the partnership was a sham formed for no purpose other than to reduce estate taxes. But the court disagreed, finding that the FLP was formed specifically for the bona fide business purpose of owning a fractional interest in an operating ranch.

The IRS also argued that the decedent had made a taxable gift when the partnership was formed. The court rejected this argument as well, explaining that in cases where taxable gifts were made on the formation of FLPs, the donors had not received interests proportionate to their contributions.