TAX BREAK

Breaking Developments by Nick R. Taylor

Strangi vs. Kimbell:  The Courts battle it out to determine estate planning law for partnerships, LLCs and corporations

 

Partnerships, limited liability companies and corporations have long been valuable tools for estate planning. Often, assets will be transferred into an entity with various restrictions. As a result of these restrictions, a client often feels comfortable making gifts of interests in the entity to family members, while providing for centralized control of the underlying assets. Additionally, discounts are often taken in the gifting and in the estate tax valuation of those interests because of the restrictions imposed.

 

Strangi

 

Thus, it was quite a surprise in the now well-publicized federal District Court case of Strangi last year that the court held that the underlying assets were to be brought back into the decedent’s estate rather than have available the discounts applicable to the entity in which the assets were held. Further, the Court implied that any right to vote in favor of distributions, liquidation or other provisions, even if a minority vote, would cause all interests that the decedent had gifted away during lifetime to be pulled back into the decedent’s estate.

 

The Strangi case, if upheld, would turn the planning world on its head. The holding of Strangi rests upon construction of Internal Revenue Code Section 2036(a) which requires that assets are to be included in the decedent’s estate if a decedent made a transfer of those assets in which he or she retained either the possession or right to the income from the property or the right, alone or in conjunction with any person, to designate who should possess or enjoy the property or income. 

 

Explicitly, 2036(a) does not apply if the transfer was a “bona fide sale for an adequate and full consideration”. Strangi announced very broad sweeping rules as to why the exception to 2036(a) would not apply in the case of the creation of a partnership or LLC. The Court held that the transfer of assets to an entity and a receipt of an entity interest in exchange for those assets was not a “bona fide sale”. The Strangi court also held that even if it was a bona fide sale, it was not for “adequate and full consideration” because the partnership interest received (at a discounted value) was not worth the value of the underlying assets transferred. The Strangi case is currently on appeal to the Fifth Circuit.

 

Meanwhile, another significant 2036(a) case has made its way to the appellate level of the Fifth Circuit and has been decided. The case of Kimbell filed May 20, 2004 is a resounding victory for taxpayers and all eyes are now on the Fifth Circuit to see if it will in fact reverse the Strangi case in light of Kimbell. To add high drama to this is the fact that the judges hearing the Strangi case on appeal are not the same Fifth Circuit judges as the ones who announced the pro-taxpayer judgment in Kimbell.

 

Kimbell

 

What did Kimbell hold and why is it so helpful to taxpayers? Kimbell involved a decedent who had created an LLC. The decedent owned 50% of the LLC and the decedent’s son and daughter-in-law each owned 25%. The son was the designated sole manager of the LLC. The LLC in turn became the 1% general partner in a general partnership. The 99% limited partnership interests were owned by the decedent.  (See the end of this article for a comparison of  Strangi and Kimbell)

 

 

Continued

 

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Nick Taylor is a member of our Tax Department who practices in the fields of estate planning, charitable giving and business succession.

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