The recent case of Estate of Kelly (March 2012) offers another

example of how family limited partnerships can be used in

business and estate planning.

In Estate of Kelly, Mrs. Kelly was an elderly widow who had succeeded

to sole ownership of her family’s substantial business and investment

holdings. Mrs. Kelly’s health was deteriorating and she lacked

experience in business and investment matters. With her children

willing and able to assist her, Mrs. Kelly formed four limited

partnerships and transferred to those partnerships specific properties

and investments.
 
Mrs. Kelly also formed a wholly-owned corporation to

act as the general partner of each limited partnership, and her children

acted as the corporation’s officers and directors. In this capacity, the

children and grandchildren actively managed the limited partnerships’

business and investment interests.
 
Over a number of years, Mrs. Kellygifted limited partner interests to her children
 and grandchildren.A tthe time of her death, Mrs. Kelly had gifted all or a majority of her

limited partner interests in three o f the four limited partnerships.

Following her death, Mrs. Kelly’s children filed her estate tax return and

reported only those limited partner interests that Mrs. Kelly had not

gifted by the time of her death.
 
The IRS asserted, nevertheless, that

Mrs. Kelly’s estate should include the value of all the properties and

investments transferred to the partnerships, apparently arguing that the

partnerships were formed primarily to avoid tax, and that Mrs. Kelly in

essence had retained the possession or enjoyment of the properties and

investments. As a result, the IRS claimed, her estate owed more than

$2,000,000 in additional tax.

The Tax Court agreed with Mrs. Kelly’s children, and ruled that her

estate should not include the value of the properties and investments

transferred to the partnerships. The Tax Court noted that there were

legitimate business reasons for creating the limited partnerships, such

as protection from potential liabilities, and delegating daily management

responsibilities to the children, as corporate officers and directors.

Further, the Tax Court observed, even though Mrs. Kelly contributed a

considerable portion of her business and investment assets to the

limited partnerships, she retained significant liquid funds outside of the

partnerships. The funds provided financial support for Mrs. Kelly, and

undermined the IRS argument that she was dependent upon, or

possessed and enjoyed, the partnership interests or assets.

Although the Tax Court’s opinion does not discuss the issue of valuation

discounts, one could reasonably assume that the limited partner

interests gifted to Mrs. Kelly’s children and grandchildren, and the

limited partner interests she continued to own at her death, were

materially discounted based on lack of control and lack of marketability

principles. Please note, however, that President Obama’s 2013 Revenue

Proposal would eliminate such valuation discounts, effective on the date

of enactment. Thus, there may be a limited window of opportunity to

apply discount valuations principles in valuing limited partner interests

for gift or estate tax purposes.

Despite their many benefits, we have previously noted that family

limited partnerships are not appropriate or worthwhile for everyone.

Nevertheless, if you own substantial investments or a successful

business, and wish to transfer ownership of the investments or business

to younger generations, the use of a family limited partnership should

be considered.