In other columns, I have told you that with proper planning, you may be able to reduce or eliminate estate taxes by qualifying your Family Limited Partnership (FLP) or Limited Liability Company (LLC) for sizable discounts.

For your ownership interests in an LLC or FLP to qualify for discounts, you must prove to the IRS that if you attempted to sell your ownership interest, you would not receive full value for it. This is to say that if you, a willing seller, attempted to sell your interest in an LLC or FLP to a willing buyer, he or she would insist on receiving a discount because your interest in the company was not large enough or of the appropriate type to allow you to control the company’s actions. This might be because you own non-voting interests or because your percentage of ownership in the company is not sufficient to allow you to impact management decisions.

The IRS has been attacking discount-motivated FLPs and LLCs for many years. Until recently, the IRS failed unless the parties had failed to comply with the required formalities or were guilty of outlandish or inappropriate behavior, such as commingling personal and business assets and expenses or making last minute death bed conveyances for which the only conceivable objective would be to qualify for discounts.

Now the IRS has another arrow in its quiver. The United States Tax Court, in the case of Strangi v. Commissioner, decided last year, has added another requirement for an FLP or LLC interest to qualify for discounts. The tax court said it would assess the full value of transferred interests if there were no constraints on the decedent’s control over the property in question. If you are like me, you probably read the last sentence, scratched your head, and said "What does this mean?"

Although the language is somewhat convoluted, what the Tax Court has done is provide a safe harbor for those seeking discounts. To qualify, you have to meet the following requirements:

The facts in the Strangi case opened the door for the IRS victory. Although the participants in Strangi complied with the formal terms of their arrangement and had a valid partnership under state law, the tax court considered the "bad facts" of the case in ruling for the IRS.

Albert Strangi’s son-in-law, Michael Gulig, established the Strangi Family Limited Partnership (SFLP) with a corporation (Stranco) as its general partner. Strangi owned 47% of Stranco and his four children owned the other 53%. All five of them were locked onto the Stranco board of directors. Gulig, as Manager of Stranco, the general partner of SFLP, had exclusive authority to act on behalf of the partners and to issue distributions. At his death, Strangi owned all 99% of the limited partnership interests and 47% of Stranco, which held the remaining 1% general partnership interest. In essence, Strangi owned almost 99.5% of the company.

The Tax Court looked at the fact that Strangi had transferred almost all of his personal assets to the FLP, leaving him without sufficient funds to pay for his own needs. He transferred his personal residence to the FLP, but then continued to live in it rent free. He also received partnership funds to pay for his back surgery, nursing costs, and personal taxes.

Strangi’s estate argued that the deceased had no legally enforceable rights over the property and that his direct and indirect management powers limited by his fiduciary duty to the other partners, were insufficient to cause these interests to be taxed at their full value.

The IRS argued there were no impediments to Strangi’s retained powers over these assets and the Tax Court agreed. It said it emphasized that the Decedent retained the right "to designate the persons who shall possess or enjoy the property or the income therefrom." The Court set out three bases for its judgment.

There was no third party control; rather, Strangi retained control, whether exercisable alone through Gulig as his attorney in fact, in conjunction with other shareholders (his own children), or in conjunction with Stranco’s President (Gulig again).

Strangi was not constrained by business reality, such as the need to deal with changes in products, competition or industry regulations, that would dictate decision-making. In the absence of such business reality, it was difficult to prove whether actions were motivated by personal wishes or realistic business objectives.

Strangi was not constrained by any independent, unrelated parties that could be expected to enforce his fiduciary duties; thus, there was no bite to any technical fiduciary duties.

Finally, the Tax Court noted that Gulig’s fiduciary duties as manager of Stranco were of little weight as compared to his confidential relationship with, and the fiduciary duties he owed to, Strangi himself. Fiduciary obligations of Stranco and its Directors were also of little significance based on Strangi’s overwhelming ownership interest.