Court Clarifies How-to Rules on Family Limited Partnerships

In a closely watched estate case, an appeals court has outlined the mistakes made by the family of a deceased Texas millionaire, providing estate planners with sharp guidelines on how to use family limited partnerships.

Family limited partnerships are often used to reduce taxes on inheritances and gifts. In this case, the family of Albert Strangi made errors that caused the U.S. Tax Court to determine that Strangi's assets should have been subject to the estate tax, the New York Times reported.

Family partnerships give parents the ability to transfer real estate and securities to their children at a lower rate than the estate tax. A portion of assets in an family limited partnership, usually from 17 percent to 55 percent, is untaxable.

When Strangi died in 1994, the Internal Revenue Service said his four children owed taxes on the entire $11 million in the family partnership, but the children argued that they owed taxes on $6.6 million.

Estate planners told the Times that family partnerships must have a business purpose other than avoiding taxes, such as limiting liabilities. Parents should not put all of their assets in the partnership because recent court opinions have shown that if the parents take payouts, estate taxes will kick in. Strangi had put 98 percent of his assets into the partnership and used assets from the partnership after it was formed.

According to Inc. magazine, many family partnerships contain assets that are not business-related, including vacation homes, personal stock, and even cash. The IRS is looking closely.

"What I always tell clients is, You really need to understand that whoever is doing the planning is likely to be audited," said Stefan F. Tucker, a partner at the Venable law firm in Washington. "It just has to be carefully done."

Edward J. McCaffery, a tax professor at the University of Southern California Law School and a lawyer specializing in estate planning, told the Times, "Memo to rich families: You can do it but do it the right way."

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