Following on its decision last year on the popular estate planning tool of family limited partnerships, the Fifth Circuit of Appeals recently issued this decision in the case of deceased Texas millionaire Albert Strangi and, in so doing, supplied a guide for what not to do in utilizing a family limited partnership.

In a New York Times article reporting the decision, it was noted that family limited partnership’s (FLPs) allow parents to transfer assets to their children at a tax rate that is lower than that assessed on estates and gifts. Under the typical family limited partnership, the parents will retain a few shares of ownership while their children will hold most of the shares. Moreover, family limited partnership’s are often set up to shield assets from the creditors of the parents, so decisions on the vehicle are closely watched by lawyers specializing in either estate planning or creditors rights.

The Strangi case began when Mr. Strangi passed away in 1994. The IRS claimed that his children owed taxes on the $11 million in the family limited partnership, while the family claimed that it only owed taxes on $6.6 million. The tax court first found in favor of Mr. Strangi's estate. However the Fifth Circuit court, in an earlier ruling, remanded the case to the tax court directing the tax court either make findings of fact and conclusions of law to explain why it failed to allow the IRS to use a section of IRC 2036a or retry the case. Internal Revenue Code Section 2036a states that assets owned by a decedent at the time of death are taxable using estate tax rates despite a prior transfer of such assets to a partnership.

Consequently, in 2003 the tax court issued a new opinion in which it held against the estate because Mr. Strangi continued to use assets contributed to the family limited partnership following its formation. For example, Mr. Strangi continued to live in his house after it had been contributed to the family limited partnership, and the tax court concluded that it could be taxed as an inheritance even though it was part of the family partnership. In fact, the tax court found that 98 percent of Mr. Strangi's assets were contributed to the family limited partnership and that the family limited partnership used its assets to pay Mr. Strangi's debts after his death.

In any event, if the obvious purpose of the family limited partnership is to avoid taxes or to shield virtually all of the parents' assets from creditors while they continue to live off such assets, then the consensus is that the courts are going to read the Strangi decision as a means of allowing the courts in disqualifying the family limited partnership from providing such a purpose..

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