Strangi But True: Recent Tax Court Case Raises Concern for FLPs and FLLCs

Fall 2003Cole Schotz DocketAttorney: Gary A. Phillips
The use of family limited partnerships (“FLPs”) and family limited liability companies (“FLLCs”) has become increasingly popular as a method for families to transfer significant amounts of wealth to children and grandchildren. The IRS has attempted over the past number of years to limit the use of FLPs and FLLCs on a number of technical grounds and, for the most part, has been unsuccessful.  Unfortunately for taxpayers, the IRS enjoyed success on May 20, 2003, when the United States Tax Court sided with the IRS in Estate of Albert Strangi v. Commissioner in a ruling that may have significant implications regarding the tax effect of FLPs and FLLCs. 


The Strangi case highlights two crucial points for partners and members of FLPs and FLLCs to review and understand.  First, the general partners of FLPs and the voting members of FLLCs must observe the formalities of their respective FLPs and FLLCs.  The ability to sustain the tax (and some of the non-tax) benefits of these entities may very well turn on being able to demonstrate that the entity is being operated as a separate business entity and that the relative ownership interests held by the partners/members are respected. 

For example, all income earned by the FLP/FLLC should be deposited directly into the FLP/FLLC account.  Distributions should not be directly distributed to the partners/members.  Furthermore, distributions from the FLP/FLLC should be made in accordance with the terms of the FLP/FLLC agreement, which means, for the most part, distributions should be made at the same time each year proportionately to the partners/members based on their underlying equity ownership in the FLP/FLLC.  Under no circumstances should the FLP/FLLC be treated as any owner’s personal bank account to pay personal expenses.  No partner/member should commingle any of his or her personal assets with the assets of the FLP/FLLC, which means that the FLP/FLLC assets should remain separate. 

Secondly, even if the business formalities of the FLP/FLLC are properly observed, based on the Strangi case, the mere retention of a general partner interest in the FLP or a voting interest in the FLLC may cause all of the assets to be taxed in one’s estate even if ownership interests had been gifted during one’s lifetime.  As a result, those owners of FLPs and FLLCs who are willing to relinquish voting control of their entities should consider gifting their entire voting interests away during life to potentially avoid Strangi’s reach.  For owners who are uncomfortable relinquishing control, the ownership and operations of the FLP/FLLC will need to be reviewed carefully to determine if the Strangi case even applies.

As a general matter, we believe the facts of Strangi are somewhat unusual, and as a result, the holding of Strangi may be overbroad.  Thus, we recommend that all owners of FLPs and FLLCs take the time now to review their entities with their advisors to determine what steps, if any, need to be taken to avoid the reach of Strangi


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