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Taxpayers successful uses of Family Limited Partnerships (FLPs) to shield wealth from estate taxes and gift taxes are being challenged by the IRS with Code Section 2036. Sec. 2036 pulls back into the taxable estate all assets over which the taxpayer retains direct or indirect control, subjecting them to transfer taxes. These assets can include those transferred to FLPs where taxpayers act carelessly in conducting relationships with the entity. The IRS use of Code Section 2036 has recently resulted in taxpayer losses in court and now represents the major challenge to a FLPs viability. To assist accountants and their clients engaged in FLPs, this article analyzes Sec. 2036 and details current tax developments, particularly the June 2003 decision in the remanded case of Strangi. The article also provides specific tax planning procedures for accountants to undertake when advising clients engaged in FLPs, so as to safeguard taxpayers assets against Sec. 2036 attack.

Family Limited Partnerships (FLPs) represent unique vehicles for transferring wealth, such as family businesses, from one generation to another, permitting parents to gradually transfer business ownership to children while maintaining control over operations. FLPs also serve as significant shields against the effects of gift and estate taxes, since valuation discounts can be employed to reduce the fair market value of partnership interests transferred to children and other family members. However, these tax savings have resulted in aggressive audit and court challenges by the IRS. For accountants, responding to these challenges for their clients means understanding both how the financial and tax aspects of FLPs operate. This article details the critical nontax aspects of FLPs and presents a thorough examination of current tax developments, including the June 2002 appellate court decisions. Finally, the article discusses specific steps accountants should take in advising their clients to protect family assets and defend against IRS attacks.