Professor Ribstein posts this interesting analysis of the Fifth Circuit’s recent decision in Kimbell v. U.S.A., Case no. 03-10529 (May 20, 2004) that is welcome relief to estate planning attorneys who utilize the popular technique of family limited partnerships to help wealthy families escape taxes.
Family partnerships — although largely untested legally — have become increasingly popular over the past decade because they allow wealthy people to transfer large amounts of money and other property virtually tax-free to their heirs. In the typical family partnership, a wealthy person transfers assets into a partnership that is usually formed with the children. In most cases, a parent serves as general partner with the children holding limited partner shares. Less often, one of the children serves as the general partner.
For the wealthy, such tax planning can save an enormous amount for heirs that would otherwise be used to pay estate and gift taxes. For example, the top federal estate-tax rate is 48%, although the first $1.5 million of a taxable estate is usually exempt from federal estate tax.
Concern about the level of protection that family limited partnerships afford increased last year when the IRS won a case involving the late Texas businessman Albert Strangi on the grounds that Mr. Strangi retained excessive control over his family partnership. That decision is currently on appeal to the Fifth Circuit.
The new decision involves the estate of Ruth A. Kimbell, who died in 1998 at the age of 96. At the time Mrs. Kimbell died, the value of the assets in her family limited partnership — which was created only a few months before her death — was about $2.4 million. When the federal estate-tax return was filed, the estate claimed a big discount on the value of Mrs. Kimbell’s interest in the partnership, to which the IRS objected.
The dispute landed in federal district court, and the Fifth Circuit reversed the district court’s ruling that had denied the estate’s request for a refund of the estate taxes and interest paid. The Fifth Circuit panel noted that the assets contributed to the partnership included working interests in oil and gas properties, that Mrs. Kimbell retained sufficient assets outside the partnership for her own support, and that there was no commingling of partnership and Mrs. Kimbell’s personal assets.
Professor Ribstein observes the following:
There remain serious potential debtor-creditor issues in these firms aside from any estate planning problems, as I discuss in Reverse Limited Liability and the Design of Business Associations. Notably, in this case the partnership was set up to insulate the owners from potential environmental liability generated by the transferred assets. But in many of these cases, as I discuss in my article, the conveyance is intended to put the assets out of the reach of a debtor’s creditors on claims that have nothing to do with the transferred assets themselves. This might stand for estate tax purposes after this case, but even if it does raises problems in the debtor-creditor context.
The case illustrates the potentially devastating impact of the death tax, here a million without the FLP discount, on an estate that is not so enormous by modern standards.
Family limited partnerships
Today’s WSJ $ discusses the recent Kimbell v. U.S. , 5th Cir. May 20, 2004, decision (on Westlaw, but haven’t found a free link), which upheld a family limited partnership for estate tax purposes. As the WSJ notes, the case