Recent Estate Planning Developments Fall 2003
New Family Limited Partnership andFamily Limited Liability Company Cases
New 2003 Legislation:Alaska Trust Law Changes.
New 2003Alaska Legislation: Uniform Principal and Income Act.
Our New Staff.
David G. Shaftel 2003.
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A Summary Provided by the: Law Offices of David G. Shaftel, PC


Numerous family limited partnership tax cases have been decided in recent years. These cases have involved both substantive tax law issues (whether the FLP qualifies for discounts) and valuation issues (how much discount should be allowed). Interestingly, the taxpayers have won most of the substantive law cases and the valuation issues are often compromised by either the court or the parties. However, three recent cases deserve special comment.

Strangi II Case

This recent Tax Court case (May 29, 2003), illustrates the old maxim that bad facts make bad law. Mr. Strangi was in very poor health, and two months before his death his son-in-law, pursuant to a power of attorney, created a family limited partnership. All of Mr. Strangi's assets were transferred to the partnership, including his residence. The general partner of the partnership was a corporation in which Mr. Strangi owned a forty-seven percent stock interest. The remaining fifty-three percent interest was owned by Mr. Strangi's daughter and grandchildren. The general partner hired the son-in-law to manage both the partnership and the corporation. During the remainder of Mr. Strangi's life and after his death, a number of Mr. Strangi's personal expenses were paid directly from the partnership.

On these facts, a single Tax Court judge issued a memorandum decision which is the first case to hold that both I.R.C. § 2036(a)(1) and (a)(2) applied to a FLP. As a result, the undiscounted value of all of the transferred assets was included in Mr. Strangi's gross estate for federal estate tax purposes.

Mr. Strangi's Retention of Income From the FLP.

Under the first of these subsections, (a)(1), transferred assets will be included in the decedent's estate, without discount, if the decedent retained the income from or enjoyment of the assets during the decedent's lifetime. The Tax Court judge held that the facts of this situation established an implied agreement between the decedent and his son-in-law that Mr. Strangi would retain a beneficial interest in the income from the partnership.

Most commentators agree that this decision was correct, and such inclusion can be easily avoided by the correct implementation of an FLP or FLLC. Commentators make the following recommendations:

do not transfer so much of the donor's assets that the donor cannot continue to live in accustomed manner without distributions from the entity in excess of distributions that would be considered normal for the type of assets held by the entity;
do not make non-pro rata distributions to owners;
do not commingle the entity's funds with personal funds;
keep accurate records reflecting the operating agreement and the entity's operations;
the GP/manager should actively manage assets in the entity;
comply with all formalities imposed by state law;
comply with partnership/operating agreement in every respect or amend the agreement to reflect changes in circumstances;
retitle all assets transferred to entity;
personal use assets should not be contributed to entity; and

contributions from other family members are helpful.

Mr. Strangi's Retention of Control of Beneficial Enjoyment. The Tax Court's more controversial holding relates to I.R.C. § 2036(a)(2). This subsection includes all the transferred assets in the donor's estate, without discount, if the donor has retained the right, either alone or in conjunction with any other person (who may even be adverse) to designate the persons who shall possess or enjoy the property or its income. Some commentators suggest it may be enough if the control is only over the timing of the beneficiary's enjoyment.

The concern here is that if the donor is the general partner/manager, or one of a group of general partners/managers, or owns an interest in an entity which is the GP/manager, then through management decisions the donor could affect a beneficiary's enjoyment of the assets. This follows because the GP/manager makes decisions concerning the distribution of FLP/FLLC profits or assets to partners/members.

Further, even a limited partner or non-manager member usually has the right to vote concerning liquidation of the FLP/FLLC.

Most agreements state that the entity cannot be liquidated unless all of the partners/members agree. The Strangi judge stated that such a right to vote on liquidation is a legal right under subsection (a)(2) which affects enjoyment of assets.

The Bottom Line Concern: If the donor retains any GP/manager or LP/non-manager member interest in the FLP or FLLC, then one interpretation of the Strangi holding is that all of the transferred assets will be included in the donor's estate without discount. For example, a donor could contribute substantial assets to an FLLC, give away all interests except a one percent manager interest, and at the donor's death all such assets may be included back in the donor's estate without discount.

Commentators differ as to how much significance should be given to the Strangi case holding with respect to subsection (a)(2). The decision is only by a single Tax Court judge and has not been reviewed by the full court nor by appellate courts. Some commentators think that the extreme facts of this death-bed planning, which involved the transfer of almost all his assets and the partnership payment of personal expenses, all combined to influence the Tax Court judge in the decision and breadth of the judge's application of the law.

However, other commentators conclude that the subsection (a)(2) holding should be respected until it is either reversed or not followed by other courts. These commentators stress that immediate planning should be accomplished to avoid the application of the Strangi decision to a client's FLP/FLLC. A number of techniques are available to do to this. These planning techniques include certain combinations of the following:

Amending certain relevant language in the partnership/operating agreement;
Giving away all FLP/FLLC interests;
Changing voting power of interests;
Making incomplete gifts to trusts;
Have several family members make significant contributions to the entity at formation;
Gifting all interests to spouse, at formation.

Review of Your FLP/FLLC. If you have formed a FLP or an FLLC, we recommend that a conference be scheduled with our office to review its implementation in view of the Strangi II case. At that time, you can decide whether to use the above-referenced approaches to avoid the implications of the Tax Court decision.

Hackl Case

Hackl v. Commissioner is over one year old but deserves review here. Often, the older generation will desire to make annual exclusion gifts (tax-free gifts of up to $11,000 per year) to their children and grandchildren. Hackl involved a family limited partnership which contained assets that produced long-term growth but little annual income. The general partner was given substantial discretion to decide when to make distributions. As a result, the Tax Court held that gifts of partnership interests did not qualify for tax-free annual exclusion gifting. The court reasoned that such interests were not “present interests” but rather were future interests. Only present interests qualify for tax-free annual exclusion gifting.

In view of Hackl, if you desire to make annual exclusion gifts of interests in your family limited liability company (“FLLC”), we recommend that your FLLC operating agreement be amended. Language will be added which will give each recipient of a gifted interest the right to sell the interest back to the FLLC for its fair market value. This right will end after thirty days. As a result, each recipient will have a “present interest” for a thirty-day period. This should be enough to qualify the gift as a present interest pursuant to case law in the Ninth Circuit.

McCord Case

Good news here. Many tax minimization approaches involve the gifting or sale of family limited liability company interests. The valuation of these interests is determined by using various applicable discounts. The IRS may challenge such valuation. If the challenge is successful, then gift tax liability will result.

As a backup safety device, sophisticated planners use what is called “ value definition” clause. That is, the amount which is transferred is defined in terms of a certain value. If the value of the transferred assets turns out to be greater than expected, the excess is returned to the transferor or given to charity.

Up until now, there has not been any case law dealing with such a value definition clause. The McCord case, decided by the Tax Court on May 14, 2003, was the first such decision. There is good news and bad news. First, the bad news is that the court held that the type of value definition clause used in that case did not work. However, the good news is the court stated that if the value definition clause had been drafted differently and implemented correctly, then the Tax Court “might have reached a different result.” This is very encouraging for a variety of transactions that have used the language referred to by the court and have been implemented through the use of a trust.

Adjust to Changing Law.

As we have discussed with you before, the tax law is a moving target. Our job is to assist you in making adjustments to your planning so that it complies with the present law. If you have used family limited partnerships or family limited liability companies in your estate planning, they should be reviewed periodically. Amendments may need to be made to your documents. The implementation of your FLP or FLLC should be discussed and adjusted to meet existing case law.


The Alaska Legislature has adopted a number of provisions which clarify and improve the Alaska Trust Act. This Act was enacted in 1997 and one of its innovations was to authorize the use of self-settled discretionary spendthrift trusts (SSDS Trusts). This type of irrevocable trust authorizes an independent trustee, in such trustee's absolute discretion, to make distributions to a class of beneficiaries that includes the settlors. Creditors of a beneficiary (including creditors of the settlor/beneficiary) are prohibited from reaching the assets of the trust. Delaware immediately followed Alaska in 1997. Rhode Island and Nevada enacted similar statutes in 1999. Utah has enacted a similar statute in 2003. Therefore, now ten percent of the states have these types of statutes. In Alaska, a number of collateral implementing provisions have been enacted during the last five years. In this 2003 legislative session, the Alaska Legislature has accomplished a significant re-write of key provisions of the Act.

Statute of Limitations. Perhaps the most novel new provisions relate to the statute of limitations for fraudulent conveyances. All of the five states' self-settled discre-tionary spendthrift trust acts provide that a fraudulent conveyance to a SSDS Trust will not be effective. However, existing statutes, and case law from other states, have created a great deal of uncertainty concerning whether a conveyance will be considered fraudulent, and when the statute of limitations runs with respect to such claims. Alaska's first change narrows the definition of what will be considered a fraudulent conveyance. The Legislature deleted the language “was intended in whole or in part to hinder, delay, or defraud creditors or other persons,” and replaced it with “was made with the intent to defraud [a creditor of the settlor].” The terms “in whole or in part” and “hinder, delay” were considered too ambiguous to allow for consistent application.

Definitions of Existing and Future Creditors. The Alaska Legislature clarified the distinction between an existing and a future creditor. This distinction is important because an existing creditor can assert a fraudulent conveyance claim within the later of four years after transfer to the trust is made, or one year after the transfer is or reasonably could have been discovered by the creditor. A future creditor may only bring a fraudulent conveyance claim within four years after transfer to the trust is made.

The new Act limits the definition of an existing creditor to a creditor who: “(1) can demonstrate, by a preponderance of the evidence, that the creditor asserted a specific claim against the settlor before the transfer; or (2) files another action, other than a fraudulent conveyance action, against the settlor that asserts a claim based on an act or omission of the settlor that occurred before the transfer, and the action described in this sub-subparagraph is filed within four years after the transfer.” These new fraudulent conveyance provisions should provide much greater certainty concerning the fraudulent conveyance exception, and a settlor should know within four years of a transfer whether a creditor can attempt to challenge a transfer as fraudulent.

New Affidavit Requirement. In a related improve-ment, the Alaska Legislature decided to strengthen the Act so as to minimize and hopefully eliminate the use of these provisions for fraudulent transfers. Therefore, the Legislature enacted a provision which states that a settlor who creates a SSDS Trust must sign a sworn affidavit before the settlor transfers assets to the trust. The affidavit must state that: “(1) the settlor has full right, title, and authority to transfer the assets to the trust; (2) the transfer of the assets to the trust will not render the settlor insolvent; (3) the settlor does not intend to defraud a creditor by transferring the assets to the trust; (4) the settlor does not have any pending or threatened court actions against the settlor, except for those court actions identified by the settlor on an attachment to the affidavit; (5) the settlor is not involved in any administrative proceedings, except for those administrative proceedings identified on an attachment to the affidavit; (6) at the time of the transfer of the assets to the trust, the settlor is not currently in default of a child support obligation by more than thirty (30) days; (7) the settlor does not contemplate filing for relief under the provisions of 11 U.S.C. (Bankruptcy Code); and (8) the assets being transferred to the trust were not derived from unlawful activities.” This new provision should protect both settlors and their professional advisors. This new affidavit requirement applies to all trusts created after October 8, 2003.

No Implied Agreements. A significant concern when designing a SSDS Trust is whether the use of a non-corporate trustee will endanger the status of the trust. The concern is that a court may find that there is an agreement between the settlor and such individual that the trustee will exercise authority in a manner desired by the settlor. A new statute has added a provision stating that “an agreement or understanding, express or implied, between the settlor and the trustee that attempts to grant or permit the retention of greater rights or authority than is stated in the trust instrument is void.”

In addition to the above-described provisions which are primarily applicable to self-settled discretionary spendthrift trusts, the Legislature adopted several new statutes that assist in the implementation of all trusts.

Beneficiaries' Use of Trust Assets. The new provi-sions also clarify that the spendthrift trust protection of a trust applies even though a beneficiary (including the settlor) may use or occupy real property or tangible personal property owned by the trust, if such use or occupancy is in accordance with the trustee's discretionary authority.

Trust Protectors and Advisors. Two trust positions are now expressly authorized by the new statutory provisions: trust protectors and trustee advisors.

The new statute defines a “trust protector” as a disinterested third party whose powers may include: the power to remove and appoint a trustee, the power to modify or amend the trust instrument to achieve favorable tax results, the power to increase or decrease the interests of a beneficiary, and the power to modify the terms of a power of appointment.

A “trustee advisor” will not be liable for the advice provided the trustee and will not be considered a fiduciary. The trustee is not required to follow the advice of such an advisor. The Act expressly states that the spendthrift protection of a self-settled discretionary spendthrift trust applies to a settlor even if the settlor serves as a co-trustee or as an advisor to the trustee, as long as the settlor does not have a trustee power over discretionary distributions. Also, such protection applies even if the settlor has the power to appoint a trust protector or a trustee advisor. Similarly, such spendthrift protection applies to a beneficiary who is not the settlor, even if such beneficiary serves as a sole trustee, co-trustee, or a trustee advisor.

Powers of Appointment. The new provisions expressly state that property subject to a power of appointment is not subject to the claims of the creditors of the donee of the power, except to the extent that the power is a general power and the donee has effectively exercised the general power in favor of the donee, the creditors of the donee, the donee's estate, or the creditors of the donee's estate.

The above-described new trust provisions apply to all existing trusts as well as all future trusts. However, the affidavit provision, described above, only applies to new trusts after the effective date of these amendments.


Alaska has updated its estate and trust legislation by enacting a version of the 1997 Uniform Principal and Income Act. Alaska's prior provisions in this area were based upon the 1962 uniform act. The new provisions are designed to implement another uniform act, the Uniform Prudent Investor Act of 1994, which Alaska adopted in 1998. The Uniform Prudent Investor Act emphasizes diversity of investments and obtaining a total return from all investments. Investing in order to maximize a total return can create a conflict between income beneficiaries and remainder-persons who receive the principal of the trust at a future date. As is discussed below, Alaska's new act provides two solutions to this conflict.

In addition, the updated Uniform Principal and Income Act contains modern concepts relating to investment vehicles and business entities. New concerns, such as environmental laws, are covered by the Act. The new Uniform Principal and Income Act also spells out timing and allocation rules.

Alaska's version of the 1997 Uniform Principal and Income Act adds changes adopted by Pennsylvania in 2002. Pennsylvania attorneys generously worked with Alaska attorneys to add technical corrections which improved Pennsylvania's original provisions. Alaska also added a change relating to allocating income to pecuniary bequests. Alaska's new Uniform Principal and Income Act applies to trusts existing on September 1, 2003, and to the estate of a decedent who dies on or after that date.

Default Rules. The Uniform Principal and Income Act provides default rules for the allocation of principal and income. That means that if subjects are not covered in the will or trust, then the Act's default rules apply. However, we can draft different provisions and they will control. Often, we will be satisfied with the Act's default rules, and they automatically become a "part of" our wills and trusts.

Why Are These Rules Important to Us- The distinction between income and principal is important for a number of reasons. For example, various estate and trust federal income tax computations are dependent upon how state law characterizes income and principal. Marital trusts created in our estate planning may require that all income be distributed to the surviving spouse. Dispositive plans may direct that income from a trust be distributed to certain beneficiaries and, after a certain date or after the income beneficiaries' deaths, that principal be distributed to other beneficiaries. Subchapter S trusts require that all income be distributed to one beneficiary. As is discussed more below, income may need to be allocated during a period of administration to pecuniary gifts. There are many other examples.

Two Approaches to Resolve the Inherent Conflict Between Income Beneficiaries and Remainderpersons. Several important areas of Alaska's Act deserve emphasis. The Act recognizes that a trustee's goal of maximizing total return from trust assets is made difficult by the conflicting interests of income and principal beneficiaries. For example, an income beneficiary will desire that trust assets be invested in income-producing assets, such as bonds, in order to maximize annual income. In contrast, the principal beneficiary will desire that trust assets be invested in assets which have long-term growth potential, such as stocks. The 1997 Uniform Act, as enacted by Alaska, includes the trustee's power to adjust. This allows the trustee to annually allocate some principal to income, or vice versa, in order to provide fair and reasonable allocations for both types of beneficiaries.

There is another solution to the above-described inherent conflict. For new trusts, instead of defining “income” as the net income earned from assets, it may be defined as a percentage of the assets of the trust, valued annually. This is called a unitrust. The trustee may then focus the trustee's efforts upon total return from the trust assets. Whether they are invested in income-producing assets or long-term growth assets, the “income beneficiaries'” annual distribution will be a certain percentage of those assets.

This unitrust concept is relatively new in the estate planning area. Many trusts exist which are of the older type which allocate all annual net income to one beneficiary, with the principal ultimately going to others. Pennsylvania's version of the Uniform Principal and Income Act, which was followed by Alaska, allows the trustee to convert such a trust to a unitrust. The trustee must give notice of the planned conversion to both income beneficiaries and the remainderpersons. If a beneficiary objects to the conversion, the trustee may petition the court to approve it. Alternatively, a beneficiary may petition the court to require the trustee to convert to a unitrust. Once converted, “income” in the governing instrument means an annual distribution equal to four percent of the trust assets. The trustee or a beneficiary may petition the court to select a different payout percentage.

IRS Position. The IRS has approved both the power to adjust and the conversion to a unitrust approaches in proposed regulations. [Prop. Reg. § 1.643(b)-1.] It is hoped that these proposed regulations will be finalized by the end of 2003. However, a theoretical issue exists with respect to converting existing trusts to unitrusts. In 2002, the IRS issued a private letter ruling which concerned many of the experts who participated in the drafting of statutes which allow for the conversion to unitrusts. In PLR 200231011, the conversion of a grandchild's income interest to a seven percent unitrust interest was found by the IRS to be a taxable event for income tax purposes. In the private letter ruling situation, a dispute between income and principal beneficiaries was settled by modification of the trust.

Many experts now think that the IRS will not pursue such a taxable event approach with respect to the conversion of income trusts to unitrusts pursuant to an express state statute. However, it will be prudent not to convert trusts to unitrusts until the IRS' position is clarified.

Allocation of Income to Pecuniary Gifts. Many wills and trusts contain provisions gifting pecuniary amounts. For example, “$10,000 to my grandchild” or “ten percent of my gross estate to my daughter.” Some marital trusts are designed to be certain amounts and therefore pecuniary gifts. In the past, Alaska has had statutes which allocate income earned during a period of estate or trust administration to such pecuniary gifts. More recently, Alaska has had a statute which provided that interest must be paid on such gifts during a period of administration. However, the IRS has taken the position that such interest is nondeductible personal interest expense. [Reg. § 1.663(c)-(5), example 7.] Therefore, Alaska decided to “clean up” this problem area in its new uniform act. The new provision now requires that a share of net income earned during administration will be allocated to all pecuniary gifts. Alaska's old interest statute was repealed.

This new provision may be burdensome for small pecuniary gifts which will be distributed at a relatively early time during an estate or trust administration. Consideration was given to providing an exception to income allocation for the payment of certain gifts during a certain time period (for example, one year). However, there was concern that such an exception might endanger the marital deduction, would eliminate one approach for qualification of allocation of GST exemption amounts, and might produce unintended gift results if an income beneficiary/trustee was making the decision of when to pay such pecuniary gifts. Therefore, it was decided that a broad income allocation rule be adopted. If a contrary result is desired with respect to certain pecuniary gifts, then this can be expressly stated in the will or trust.


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