The Strange Case of Strangi (Or "Life is Strangi(er) than Fiction")

Way back in 1993 in Texas, Mr. Strangi ended up sick with cancer, and gave his son-in-law, an attorney, authority to handle his affairs.

The son-in-law (we will call him “Bob”) set up a Texas Family Limited Partnership (FLP) with a corporate general partner.

He contributed $9,876,929 to the Limited partnership. This amount equaled 98% of Mr. Strangi’s assets and included his home.

We know these numbers because of the subsequent publicity received by the transaction. Texans are usually publicity shy, especially when it concerns money.

We know that putting your home in a FLP is bad, as is not holding back enough assets to pay for your estimated living expenses. So these two slip ups are probably the ones that caused the resulting publicity and the costs of the ensuing tax court cases.

Prior to Mr. Strangi’s death the following year (a scant 2 months after the partnership was set up), the partnership made distributions only when needed by Mr. Strangi. Again, a problem when not enough money is held back.

After Mr. Strangi passed away, the son-in-law, Bob, filed the estate tax return, claiming a valuation discount of 40%. This discount saved the estate about $2.2 million in estate taxes, or about $550,000 for each of Mr. Strangi’s children, including one of whom was married to Bob, the son-in-law and lawyer.

The IRS examined the facts, the most important of which are presented above, and decided that the partnership was not truly a partnership, but in fact a “piggy bank” that was set up solely to reduce the amount of estate taxes that would ultimately be payable, and determined that the FLP had no other established business purpose. The IRS sued in tax court to collect the $2.2 million in taxes which it thought the estate owed. A very expensive trial took place and all the details of the family, their money and the tax bill were exposed and discussed publicly all around the country.

Fortunately, despite the poor set of facts presented, the tax court ruled that the taxpayers (Strangi family) were right; the FLP was found to be a valid partnership and the discount was allowed. Great news! (Lesson here: If you are going to go to tax court, do it in Texas; they hate taxes in Texas.)

However, the IRS appealed the case to a higher court, and amazingly the higher court came back and said the lower court was right, except for one thing. During the trial, the tax court had refused to listen to an argument from the IRS that no discount should be allowed due to a section of the law called “2036”.

Section “2036” says that if you give your property away but retain an interest in it (right to income, use, enjoyment or possession) then it is all taxable as part of your estate. Since the FLP was in fact just a piggy bank, it could be considered a trust, with Mr. Strangi having retained an interest in it. He was in fact living rent-free in the FLP’s property-his former home- which he had unwisely contributed to the FLP.

Well, it’s a great argument for the IRS because if proven right it calls all the property back into his estate, EVEN that which have been given away to others. This was really bad news to the estate and children of Mr. Strangi. Forget using discounts, this argument even brings back into the estate any gifts he may have made to others without discounts.

The higher court sent it back to the tax court to reconsider the case, with instructions this time to include the section “2036” law which the tax court had ignored first time because of a foot fault on the part of the IRS. The second time the IRS won everything. The entire FLP without discount was ruled to be included in the estate and the additional $2.2 million in estate tax needed to be paid.

The case went back to the appeals court again, and this time the appeals court agreed with the tax court and said the estate must pay up. Ouch!

It’s important to note that the appeals court was not making law, just saying that in this case, with a bad set of facts, the section “2036” law applied. This is not a denial of the benefits of all FLPs, just this one.

Cases like this are exactly why we have gone to the effort of creating a “MyFlp Owners Kit” to keep this fact pattern, or others we find just like it, from hurting you. If you don’t know about what won’t work, how do you know your FLP will work?

Here again are the facts that caused the audit, publicity, expense and additional $2.2 million in taxes for the family:
1) The FLP was operated as a piggy bank (my words, not the tax court’s)
2) Mr. Strangi contributed non-business property to the deal -his house- which he continued to live in rent-free.
3) He contributed the vast majority of his assets, leaving virtually none behind with which to pay his expenses (rent?), medical bills etc.
4) He continued to “possess and enjoy” the property that was in the FLP.
5) The fact that Mr. Strangi died just a couple of months after the FLP was set up probably didn’t help.

These facts could have been adjusted, and the result would have been a lot different. The real culprit, in my view, was someone trying to be too clever, and the end result was that they got caught and were hung out to dry.