Mrs. Kimbell's contribution to the partnership, the court said, was made in exchange for equivalent FLP interests. The interests credited to each of the partners was proportionate to the fair market value of the assets they contributed, and the partners were entitled to distributions equal to their respective capital accounts on termination of the partnership. The Court also found that the transaction was genuine, even under "heightened scrutiny" of the objective facts.
Looking hard at the Kimbell case, two reasons emerge that explain why the court gave the Kimbell family a free pass. First, Mrs. Kimbell avoided bad facts. She retained, for example, sufficient assets outside the partnership for her own needs; she did not commingle personal and partnership funds; she satisfied partnership formalities; and she actually assigned assets to the partnership in exchange for her partnership interest.
Second, there was business purpose. There were working interests in oil and gas properties requiring active management contributed to the partnership. The court also cited Mrs. Kimbell's other business purposes, including asset protection, pooling of family investments and continuation of family ownership. In looking at business purpose, the court reviewed past Tax Court cases-those showing genuine business purpose (like the ranch operation in Church and the active business operations and settlement of family litigation in Stone) and transactions with bad facts like Harper (absence of negotiations, a mere "recycling of wealth"), Thompson (no active business) and Strangi III (a mere "recycling of wealth"). While it may not take much to meet the Fifth Circuit's requirement for business purpose, there is little question that there needs to be one.
Kimbell is not, however, the law of the land. The decision is binding only in the Fifth Circuit. It does not definitively define for taxpayers in other jurisdictions what is needed to have a bona fide transaction for full consideration that gets you out from under 2036. The Fifth Circuit also has a pro-taxpayer history, and another court, looking at the same facts, might reach a very different conclusion. The bottom line is that the strength of the business purpose sufficient to qualify for the 2036 exception as a bona fide transaction for full consideration, or alternatively the Strangi III safe harbor, may vary from jurisdiction to jurisdiction.
Stacking The Deck
Whether placing your bet on fitting into the Strangi III safe harbor or the exception to 2036, the common denominator of taxpayer success is clear: business purpose. Properly formed and managed entities with true business purpose will succeed in both the gift and estate tax discount games. Business purpose makes the difference: Taxpayers without it are just rolling the dice.
B. Dane Dudley, Steven M. Fast and Darren M. Wallace are estate planning lawyers at Day, Berry & Howard LLP, practicing in the firm's West Hartford, Conn., office.