TAX BREAK

Breaking Developments by Nick R. Taylor (continued)

 

Under Strangi rationale, the Court would likely have held that there could not have been a bona fide sale because this was a family transaction, that the transfers into an entity and receipt of the entity interest are not a sale in any event to qualify for the exception to 2036(a), that the receipt of the partnership interest was not of equal value to the assets contributed so the exception to 2036(a) did not apply and that 2036(a) would result in inclusion of the underlying assets in the decedent’s estate because of the right of the decedent as a 50% owner of the general partner to be able to ultimately vote in conjunction with others concerning administration of the general partnership.

 

Not so the court in Kimbell, however. The Kimbell court rejected the Strangi rationale that a bona fide sale needed to involve two parties who were not related. The court held was all that was required to be a bona fide sale was for the decedent to have “actually parted with her interests in the assets transferred and the partnership/transferee actually parting with the partnership interest issued in exchange”. The court went on to hold that to be for adequate and full consideration simply requires that “the exchange of assets for partnership interests must be roughly equivalent.”  The court applies this rough equivalence test in the context of a partnership to require only the following three criteria which would typically be present in the creation of any partnership:

 

1.         That the interest credited to each of the partners was proportionate to the fair market value of the assets each partner contributed to the partnership;

2.         The assets contributable to each partner of the partnership were properly credited through the respective capital accounts of the partners; and

3.         On termination or dissolution of the partnership, the partners were entitled to distributions from the partnership in amounts equal to the respective capital accounts.

 

Because the court holds that the transfer of assets into the entity was a bona fide sale for adequate and full consideration, the transfer fell squarely within the exception to 2036(a) and no inclusion of entity assets could result in the decedent’s estate.

 

While Kimbell is extremely helpful, what remains unanswered are the following:

 

a.         Precisely how much of a business interest is needed, other than pure tax saving motivations, for the transaction to be respected?

b.    Will the Fifth Circuit follow the Kimbell rationale in its upcoming decision on Strangi?

c.         How important in the Kimbell decision was the fact that there were operating oil and gas interests to make this an active partnership rather than simply passive investments?

 

The stage is set for the next ruling – hopefully a ruling consistent with Kimbell and one that will tend to provide more certainty and predictability in the area of planning. We are currently helping clients establish entities with these potential tax issues taken into account in the design decisions.

 

 

Continued

 

 

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