Tread carefully if you are thinking of moving family estate assets into a partnership to reduce your tax burden. A U.S. Tax Court decision is making it more difficult to use the partnerships to shield assets, the Wall Street Journal reported.
The 2003 Tax Court decisions, now on appeal, revolved around a partnership set up by businessman Albert Strangi over which, the court found, he had too much control.
Family limited partnerships are under the microscope as the Internal Revenue Service cracks down on what it considers to be misuses of the strategy to avoid paying large amounts of taxes. The strategy typically involves transferring assets into a partnership that includes a person's heirs-often their children, the Journal reported.
The latest case is that of Wayne C. Bongard, a businessman who died in 1998. His strategy included transferring assets to a holding company and later to a family limited partnership. The court was asked to rule whether the transfers were legitimate under tax rules, the Journal reported.
Among the assets usually moved into partnerships are money, stocks, bonds and shares in family-owned businesses. Usually the parent with the assets retains management and investment control with the children acting as limited partners.
The recent case, while complicated, dealt a partial victory to both sides and offered hints into how to structure the partnerships to withstand IRS challenges.
The court had to decide whether shares transferred by Bongard to a holding company had to be included in his gross estate. The majority opinion ruled there was a "legitimate and significant non-tax reason" for the transfer, thus reducing the tax burden. However, the court also ruled that the holding-company interests transferred to the partnership should be included in Bongard's gross estate, thus increasing the tax hit, and sparking worries among estate planners, the Journal reported.
These partnerships are "still solid planning tools but must be used with much more care and much more consideration," Stephan R. Leimberg, publisher of newsletters for tax professionals, told the Journal.
John W. Porter, a lawyer at Baker Botts LLP who represented the Bongard estate, told the Journal Tuesday that the estate has yet to decide on an appeal. An IRS spokeswoman declined comment.
So how can you create a partnership that is likely to hold up under IRS scrutiny? The partnership should have "legitimate and significant business reasons" to exist, such as managing a family business, rather than just dodging taxes, David A. Handler, a lawyer at Kirkland & Ellis in Chicago, told the Journal. Also, if you transfer assets into a partnership, don't retain total control over them -- and avoid dipping into those assets for personal expenses. Retain sufficient assets, "outside of the partnership, to maintain your lifestyle," he said.