Strangi owned 47% of the corporate general partner, with the remaining 53% owned by his four children. Later, a 1% interest in the corporate general partner was given to a tax-exempt 501(c)(3) foundation. Unlike some earlier cases, the Strangi FLP obligated the managing general partner to use good-faith efforts to manage the partnership in a prudent, business-like manner, and to act in the best interests of the partnership.

Strangi died shortly after the formation of the FLP, and the operation of the FLP by his children was more than a little suspect. The Tax Court noted that the FLP: 1) Paid for back surgery for the decedent's housekeeper, 2) Paid more than $100,000 to cover funeral expenses, estate expenses, debts and bequests, 3) Distributed $3,187,800 directed toward the decedent's estate and inheritance taxes.

Under §2036(a)(1), a transfer of assets is disregarded if the decedent retains during his lifetime "the possession or enjoyment of, or the right to the income from, the property." The Tax Court held that there was an implied agreement for Strangi to continue to enjoy the economic benefit of the assets. First, Strangi contributed approximately 98% of his wealth, including his residence, to the FLP, and essentially had no retained assets on which to live. Second, the Tax Court emphasized that Strangi was allowed to occupy his personal residence after it was transferred to the FLP, and while there were book entries to show the payment of rent, no rental payment was actually paid. Ultimately, the court concluded, "The crucial characteristic is that virtually nothing beyond formal title changed in decedent's relationship to his assets." Decedent's children did not raise objections when large sums were advanced for expenditures of decedent or his estate, thus implying an "understanding."

Having found that the transfer could be disregarded under §2036(a)(1), the Tax Court went on to address §2036(a)(2). This provision applies to a transfer if the decedent retained during life "the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom."

The estate argued that Strangi had no legal control over the FLP, since he was a minority shareholder in the corporate general partner, and that Strangi, or the corporate general partner, would be subject to state law fiduciary duties as a general partner in the partnership.

However, the Tax Court distinguished U.S. v. Byrum, 408 U.S. 125 (1972), because the fiduciary duties in that case "ran to a significant number of unrelated parties and had their genesis in operating businesses that would lend money to the standard of that being the best interest of the entity." The Tax Court concluded that Byrum does not require a "blind application of its holdings to scenarios where the purported fiduciary duties have no comparable substance."

The Tax Court concluded that Strangi retained the right, in conjunction with others, to designate the persons who would receive the income from the assets transferred into the FLP, and that, therefore, §2036(a)(2) caused the transfers to be disregarded.

The New Road to Success

The IRS' recent attacks on FLPs teach the basic lesson that you not only need to build the vehicle properly, but also to operate it correctly. However, Strangi II raises serious risks beyond that, namely that the vehicle itself may be unsafe at any speed.

In Strangi II, the Tax Court ultimately took the position that an FLP composed solely of family members, coupled with other indications of family cooperation, may permit the IRS to ignore entirely the form, and even the operation, of an FLP. By restricting the Byrum decision and its application to FLPs, the IRS has created great uncertainty and huge economic risk.

So what is a wealthy American family to do? A possible way to avoid §2036(a)(2) is to operate an actual business within the FLP, since the inherent constraints of operating a "real" business, including bank relationships, would create meaningful constraints on the ability to make distributions and thus, at some point, would trigger application of the Byrum case. However, in many FLP planning situations the intent was to avoid risk within the FLP, and therefore, at the very least, this is not a good solution for many people.