Strangi II Deflated: Homerun for the taxpayer!

Sample Reply Only

April 23, 2004 

Mr. Lawrence Feldman, CPA
DT&T Global Consulting
2365 Hawthorne Avenue, Suite 1900
Boston, Massachusetts  02109-8198

Dear Mr. Feldman, 

Concerning the convenient singling out of the one of the few IRS favorable decisions, currently on appeal, Strangi II (May 2003), is tantamount to biased selection of case law that favors the position of the Service and ignores the bad fact pattern of this case and its dissimilarities with the Smith Family Limited Partnership (“SFLP”).   

The SFLP was/is a fully functioning business enterprise distinct from the individual and having adhered to partnership formalities; met the requirements for the bona fide sale exception; the transferor received consideration equal to the value of the transferred property, the transferor’s estate was not depleted and there was no reason to impose the gift or estate tax on the transfer; and Chapter 14 does not appear to apply; therefore, it appears unnecessary to examine the Sec. 2036 (a)(1) issues.   

The bad facts of Strangi II include, but are not limited to:  (a) The decedent’s son-in-law was the attorney in fact for the entities and exercised management over their financial affairs, which could result in  impairment due to conflicts of interest; (b)  Assets held included his personal residence; (c)  Seventy five percent of the value was held in marketable securities versus an actively operating business; (d) Distributions were shown to be made based upon Mr. Strangi’s personal needs and the needs of his estate; (e) The FLP was not complex and did not have a clear business purpose; and (e) the transfer was considered “death bed”. 

As I understand it, the interests (4.0% GP and 34% LP) held by the decedent would be assignee interests (consistent with McLendon v. Commissioner) upon transfer under the fair market value standard and the formal structure required by the LP agreement was respected by the partnership interest holders.  Also, this was clearly not an extreme interest size (compared to Strangi’s 99%) and upon transfer it would not retain voting rights. Further, the SFLP holds substantial real property that had an effective pre-tax yield on assets of only 4.5%, suggesting a growth and not necessarily an income orientation by an investor.   

The LP did not include all of the decedent’s individual assets.  Consideration should be given to the decedent’s other holdings, as it is unlikely he was reliant on the SFLP as his sole source of income.  The decedent’s power to have had decision making authority to receive or direct whom would receive a distribution is unlikely to constitute a “right” under state statute, as it is not guaranteed based upon management’s required fiduciary duties due all interest holders without regard to family attribution.  Further, the property held was for commercial and not personal use of several related party entities; however, there is no indication the relationships were not at “arm’s length” or whether the only valid consideration is whether the transfers were a “sham”.  Further, the distributions were made at proportionate amounts and there was no implied agreement among the parties that the economic benefits of the contributed property would be solely retained.           

Provisions of the SFLP agreement require an affirmative vote of 70% of the outstanding partner interests, which the decedent did not hold; therefore, he would be unable to unilaterally terminate the LP.  A two-thirds vote is required prior to any interest transfer; therefore, he did not retain the right alone to designate the persons who will receive the possession, enjoyment or income from the properties held.  Further, distributions may be made either in cash or in property (with the later likely resulting in eliminating any Sec. 2036 argument), which may not necessarily have identical cash equivalent values; however, LP interest holders agree not to partition these assets.  In addition, the SFLP provisions call for retention of reserves, which appear to have been decided based upon review of historic balance sheet cash balances.  

           Aside from it not being law with definitive guidelines, an examination of the Tax Court Memorandum decision in Strangi II, suggests a reliance on the broadest possible interpretation of Sec. 2036(a) “retained interest argument” and is in contrast with recent findings in Stone, E.M. Dailey, Lappo and Peracchio as well as findings in Church and Harrison (Also see Sec. 2043 – What paid for versus what includable in gross estate.).   

          Further, a review of Sec. 2503-3(a) may suggest the giving away less than one holds and limitations on transfers as well as “adequate consideration” are arguably economic/valuation issues and not necessary matters solely of law. 

          Also, one must determine the extent the interest is retained and not necessarily the retention itself.  One must also consider whether it is the direct ownership interest in the entity being valued and not the underlying assets held with non-controlling interests having (no)minal influence on the sale of such assets at their optimal level(s) of value.   

One must also determine whether the fiduciary duty standards (under U.S. v. Byrum) imposed were met by acting in the best interest of the shareholders and the entity and if there was a clear and legitimate business purpose.  It may be argued there was a strong non-tax motivation designed to minimize future litigation among parties with the assistance of various legal and financial advisors as well as other reasonable business purposes providing an applicable bona fide sale exception despite such a requirement being less than objective.  These were underscored in the report.  I believe this burden under Code Sec. 7491(a) is that of the Service. 

          The November 2003 Tax Court decision in Stone outlines that if transfers were for adequate and full consideration in money or money’s worth without regard to whether adjustments were made to the pro rata interests; then the bona fide sale exception is applicable; especially if negotiations occurred among involved parties preceding the creation of the LP should such an issue be germane.  It appears clear to this analyst transfers were motivated by business and investment concerns relating to the management of the assets.   

Given the above area(s) of clarification, the arguments of inclusion of SFLP’s assets in the decedent’s gross estate under IRC 2036(a)(2) appear to be without merit and are highly suggestive there would be no acceptable circumstances that would permit administrative error within the LP agreement or actions by the LP interest holders.  Based upon these factors, I feel the application of the aggregate value adjustments to the decedent’s pro rata LP interest(s) of 51.7% are well supported.

 Please contact me should you have further comments, questions or concerns.

Respectfully Submitted, 

ALLISON APPRAISALS & ASSESSMENTS, INC.

Carl Lloyd Sheeler, Ph.D., CBA, AVA
Managing Partner

 CLS:jw