More Timing Difficulties in Family Limited Partnership Formation Transactions

Prior court decisions have told us that the timing of the steps in setting up a family limited partnership are important. If a taxpayer forms the partnership, gifts interests to gift recipients (e.g., children), and THEN contributes property to the partnership, these decisions provide that the gift involved is a gift of the property contributed to the partnership, and not the partnership interests themselves. The effect of this is that the gift is an undiscounted gift - the property transferred is valued at full value, instead of being a gift of a partnership interest that usually will qualify for valuation discounts (and thus a lower gift tax value for purposes of computing gift tax).

Until now, it has been assumed that if the set up was done in the right order, the foregoing negative result would not apply. That is, if the property was transferred to the partnership first, and THEN the founding partners gifted partnership interests, this should constitute a gift of partnership interests only, and not the contributed property.

The Eight Circuit Court of Appeals has muddied the waters. By invoking the "step transaction doctrine" in a recent case, it may have opened the door to the gift being treated as a gift of the property contributed to the partnership and not a gift of partnership interests, EVEN IF the property contribution preceded the gift of partnership interests. The step transaction doctrine allows the IRS to reorder the steps of a transaction, or ignore intervening steps, in determining tax consequences if all of the steps of the transaction are integrated/interdependent. In context of these transactions, it allows the IRS to ignore the form of the transaction and reorder these steps in a way that does not allow for the desired discounting.

It is not known if this is a correct intepretation of the case, but some commentators believe it may be. Planners should now include planning to avoid a step transaction doctrine attack as part of their family limited partnership formation planning.

SENDA v. COMM., 97 AFTR 2d 2006-XXXX, (CA8), 01/06/2006