First Place Winner 2005

                                       
FLPs and the 2036(a) Bona Fide Sale Exception: The Vital Role of the Presumption of Adequate and Full Consideration
 
by Layne T. Smith
Provo, Utah
 
This article is the winning submission in the Second Annual Mary Moers Wenig Student Writing Contest. Layne attended the J. Reuben Clark Law School at Brigham Young University and was a student of ACTEC Fellow Professor Stan Neeleman.
 
This year 35 papers were submitted with 22 law schools represented. The second place paper was by Allyson Belt of Arizona State University, entitled “Medicaid Estate Planning: A Review of the Ethical Considerations of Practicing Medicaid Estate Planning in the Area of Elder Law.” The third place winner was Chris Suffecool of Arizona State University, who wrote on “Organ Transplants, the Uniform Anatomical Gifts Act and Probate Law: Is it Time for a New Approach?” ACTEC Fellow and Adjunct Professor John Becker taught Allyson and Chris. Both the second place and third place winners can be found on the ACTEC website.
 
The ACTEC Foundation generously provided the funding for this year’s competition. The first place winner received a prize of $5,000, the second place winner received a prize of $3,000, and the third place winner received a prize of $1,000. The Legal Education Committee administered the contest with Ira Bloom arranging for the announcement of the contest to be sent to all the law schools and Mary Radford coordinating the grading. A subcommittee of the Legal Education Committee judged the papers, the members of which were Skip Fox, Randy Gingiss, Anne-Marie Rhodes and Len Witman. Details of the 2006 competition, which has already started, can be found on the ACTEC website. Fellows who know of law students who might be interested in the contest are urged to inform those law students of the contest.
 

I.

Introduction

  Over the past several years, the Internal Revenue Service (the "Service") has enjoyed success in a string of cases involving the use of the family limited partnership and the family limited liability company as estate planning vehicles. The Service’s victories may be motivating many taxpayers to take more conservative positions in claiming valuation discounts on family limited partnership interests.[1] But practitioners and commentators have responded with a barrage of literature criticizing decisions that favor the Service,[2] and the family limited partnership continues to be an often-used instrument in the estate planner’s toolbox.[3]
 
  When a taxpayer transfers property to a family limited partnership or a family limited liability company (for simplicity, both entities are referred to herein as an "FLP"), the partnership interests received in return typically qualify for valuation discounts from net asset value of as much as forty percent. This allows a taxpayer to then transfer the partnership interests to family members at significant transfer tax savings, and all the while, the transferor may, if desired, retain certain control over the partnership assets. The abuse invited by this unique combination of benefits necessitates the continued tightening of the estate tax law governing FLPs.[4]
 
  The Service’s most effective tool of late for attacking abusive FLPs is Section 2036 of the Internal Revenue Code. This section pulls transferred property back into a taxpayer’s estate if the taxpayer retains enjoyment of the property, the right to income from the property, or the power to control who enjoys the property or income from the property.[5] However, Section 2036 contains an exception for bona fide transfers made for adequate and full consideration in money or money’s worth (the “bona fide sale exception”).
 
  Seeking refuge from the grasp of Section 2036(a), taxpayers have argued for a liberal application of the bona fide sale exception. The Fifth Circuit in Kimbell v. United States[6] has adopted such an interpretation by failing to apply the heightened scrutiny required for transfers among family members. Meanwhile, the Tax Court has applied a stricter, more appropriate standard when evaluating whether transfers to an FLP qualify for the bona fide sale exception. Nevertheless, even the Tax Court is confused concerning the proper standard that should be applied to determine when a transfer qualifies for the bona fide sale exception, as evidenced by the Tax Court's recent attempt in Estate of Bongard v. Comm’r[7] to formulate a new rule governing when the exception should be applied to FLPs.
 
  This confusion is a result of the failure to recognize the proper justification for holding that a discounted partnership interest constitutes adequate and full consideration. Normally, consideration is adequate and full when its value equals that of the transferred property, but the value of a discounted partnership interest will never equal the value of the property transferred to an FLP. Rather, the only time a discounted partnership interest should qualify for the bona fide sale exception is when it is obtained through a transfer in the ordinary course of business. Courts may presume that transfers in the ordinary course of business are for adequate and full consideration in money or money’s worth. This is the only proper justification for finding that a discounted partnership interest qualifies for the bona fide sale exception.
 
  Part II of this Comment provides a background discussion of how FLPs are used as tax planning vehicles. Part III introduces Section 2036(a) and discusses how the Third Circuit, the Fifth Circuit, and the Tax Court have applied the bona fide sale exception. Part IV explains why a discounted partnership should never qualify for the bona fide sale exception on the grounds that it replenishes the estate. It also demonstrates that the only way such an interest should be able to qualify for the exception is through a presumption of adequate and full consideration, and this presumption is only appropriate where the transfer is bona fide, made at arm’s length, and involves no donative intent.
 

II.

The Use of Family Limited Partnerships as Estate Planning Vehicles

  The FLP can be a valuable tool for managing a large estate. It potentially allows wealthy individuals to retain control over their assets and simultaneously decrease the value of their gross estate by as much as forty percent.[8]
 
  In a prototypical estate plan employing an FLP, the taxpayer will transfer a substantial portion of her assets to the FLP, retaining sufficient assets to provide for her personal support. In exchange, the transferor taxpayer will take a general partnership (“GP”) interest in the FLP’s equity, typically one percent of the partnership interest, and a limited partnership (“LP”) interest representing the remaining ninety-nine percent. The taxpayer may then engage in a gifting program and transfer the LP interest to her heirs, taking advantage of the $11,000 annual gift tax exclusion and the applicable exclusion amount. Whether the taxpayer makes inter vivos or testamentary transfers of her interests in the FLP, those interests will qualify for significant valuation discounts, thus reducing, or potentially eliminating, the transfer tax that would otherwise be incurred on the disposition of the property.
 
  A. Valuing FLP Interests at a Discount from Net Asset Value
 
    The standard under which partnership interests are valued for transfer tax purposes opens the door for significant valuation discounts. For gift and estate tax purposes, the standard for valuing property, including interests in businesses such as FLPs, is the “fair market value” standard.[9] The fair market value of property is “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.”[10] The willing buyer and willing seller are hypothetical persons, not “the actual transferor nor the actual transferee.”[11]
 
    In general, contributing property to a legal entity in exchange for an ownership interest alters the nature of the transferor’s property rights, often dramatically. This frequently causes a disparity between the value of the contributed property and the value of the interest received.[12] In the case of an FLP, the disparity can be substantial and takes the form of a lack-of-control discount and/or a lack-of-marketability discount.
 
    Under the fair market value standard, the value of a minority LP interest in an FLP is discounted from net asset value for the lack-of-control associated with such an interest. The lack of control discount is based on the theory that an outsider who purchases a minority interest in a closely-held family business has no means of assuring that the business will make distributions or that she will receive an income-paying position in the company.[13] Plus, under partnership law, an owner of an LP interest does not have the power to force liquidation of the partnership. Due to this uncertainty as to when, if ever, the acquired interest will produce economic benefits for the investor, the amount that an outsider would pay for an LP interest is discounted for the lack of control associated with that interest.
 
    In addition, both LP and GP interests in an FLP qualify for a lack-of-marketability discount from net asset value. Unlike publicly-traded securities, there is rarely a ready market for FLP interests. The resultant difficulty associated with liquidating these interests justifies a discount for lack of marketability.[14]
 
    A taxpayer who transfers property to an FLP in exchange for a discounted partnership interest may receive one of several intangible benefits that compensate for the “immediate destruction of value” that occurs upon making the transfer.[15] Some of these benefits are personal to the taxpayer. Examples include involving the children in management of the property, obtaining financial leverage over the LP interest holders (often the children), creating a testamentary plan, or facilitating a gifting program. Other intangibles are benefits that would be valuable to any interest holder in the FLP. Examples might include asset protection against creditors or management expertise.[16]
 
    In the eyes of the transferor of property to an FLP, the fair market value standard often “understates actual value.”[17] A lack of control and marketability would be a substantial concern to the hypothetical buyer and seller; however, it is often not an important factor for a family member interest holder, especially where family members work together in harmony. Also, the fair market value standard fails to take into account for valuation purposes those benefits of the FLP form that are personal to the transferor. In effect, under the fair market value standard, the transfer of property to an FLP may create a valuation discount on paper that is much greater than in the mind of the transferor.
 
    1. An illustration of the power of discounts
 
      The following example illustrates the transfer tax advantages an FLP can offer.[18] Assume Father (F) and Mother (M) own a business worth $4,000,000 in equal shares, and they transfer their interests therein to an FLP. In return, each takes a 0.5 percent GP interest and a 49.5 percent LP interest in the FLP. Assume further that the LP interest qualifies for a combined 30 percent lack-of-control and lack-of-marketability discount and that the GP interest qualifies for a 10 percent lack-of-marketability discount. If M and F have two children and four grandchildren, utilizing the annual exclusion and the applicable credit they can gift their entire LP interests to their six heirs over a six-year period without incurring any gift tax.[19] The valuation discount created by usig an FLP allows the taxpayers to transfer $1,188,000 in assets tax-free.[20]
 
      Adding to the attractiveness of the FLP, through their continued ownership of the GP interest, F and M retain complete control over management of the FLP, including whether the business makes distributions to the interest holders and whether their children and grandchildren receive highly compensated employment with the family business. Moreover, upon the death of F and M, their GP interest still qualifies for the 10 percent lack of marketability discount for estate tax purposes.
 
  B. Ensuring Transferred Assets Are Not Pulled Back Into the Estate
 
    To benefit from these valuation discounts, the taxpayer must comply with certain partnership formalities and the FLP must have a certain level of substance. Otherwise, the taxpayer may be forced to include in her gross estate the assets transferred to the partnership at their fair market value instead of the value of the discounted partnership interests.
 
    1. Heightened scrutiny required in the family context
 
      Whenever a taxpayer makes a transfer of property to a family member or a family-owned entity, the transaction is subject to heightened scrutiny for tax purposes. Courts presume that "the intra-family transfer is not at arm’s length.”[21] Rebutting this presumption entails inquiring “beyond the form of a transaction between family members to determine whether the substance justified the claimed tax treatment.”[22] Such special scrutiny is necessary because, as the Supreme Court has recognized, “the family relationship often makes it possible for one to shift tax incidence by surface changes of ownership without disturbing in the least his dominion and control over the subject of the gift or the purposes for which the income from the property is used.”[23]
 
    2. Structuring an FLP to withstand heightened scrutiny
 
      The single most important characteristic an FLP should have to withstand heightened Service scrutiny is a legitimate, nontax business purpose.[24] Perhaps the most persuasive business purpose for using an FLP is facilitating the active management of the FLP assets.[25] Other potential business purposes for using an FLP include: (1) pooling assets for investment purposes; (2) preventing disputes between family members; (3) enabling children to participate in or take over management of assets; (4) consolidating fractional interests in family assets; (5) restricting the rights of third parties from acquiring interests in family assets; and (6) protecting assets against future claimants.[26] Merely stating that an FLP is formed for these or other business purposes is insufficient. Courts will scrutinize the substance of the FLP to see if the claimed purposes are indeed the true motivation for its creation.[27]
 
      Aside from having a business purpose, to ensure the assets in an FLP are not drawn back into the transferor's estate, taxpayers should “carefully follow all formalities in forming and operating the FLP and respect the form of the partnership.”[28] This includes carefully maintaining “contemporaneous books and records reflecting all partnership transactions” and ensuring the partnership has its own checking account.[29]
 
      Also, the individual interest holders must respect the form of the partnership and avoid any indicia of continued ownership of the transferred assets.[30] The partnership should “operate at arm’s-length” with all interest holders and family members.[31] Partnership assets should not be commingled with personal assets, and if the FLP makes loans to family members, they should be carefully documented, market-rate interest should be charged, and timely payments should be enforced.[32] The FLP should make distributions pro rata and should not time them to meet the family members’ personal needs.[33] Also, distributions should be made to the distributee partner, and not to the partner’s creditors.[34] Finally, it is best not to fund an FLP with “personal use property, such as the principal residence or the family’s art collection.”[35] Taking such precautions ensures that the taxpayer’s relationship to her property changes when it is transferred to an FLP.
 

III.

SECTION 2036(A) AND THE BONA FIDE SALE EXCEPTION

 
  A. Section 2036(a)
 
    Recently, the Service’s most potent weapon for attacking the abusive use of the FLP is Section 2036(a).[36] Section 2036(a) provides:
 
      The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death--
 
      (1) the possession or enjoyment of, or the right to the income from, the property, or
 
      (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.[37]
 
    Congress enacted Section 2036 to prevent avoidance of the federal estate tax “by the use of inter vivos transactions which do not remove the lifetime enjoyment of property purportedly transferred by a decedent.”[38] As the Supreme Court explained, such transfers are “essentially testamentary” in that they “leave the transferor a significant interest in or control over the property transferred during his lifetime.” [39] Under 2036(a), “[a]n interest or right is treated as having been retained or reserved if at the time of the transfer there was an understanding, express or implied, that the interest or right would later be conferred.”[40]
 
    The Third Circuit opinion, Thompson v. Commissioner,[41] illustrates the application of Section 2036(a) to an abusive FLP. The decedent, Mr. Thompson, transferred $1,286,000 in property consisting of securities, notes, and a ranch to the Turner FLP in exchange for a 95.4 percent LP interest. The decedent’s son-in-law contributed $50,000 in assets to the partnership in exchange for a 3.54 percent limited partnership interest. A corporation owned by Mr. Thompson (49 percent) and by members of his family and a charity (51 percent) held the remaining 1.06 percent GP interest. The Turner FLP never “engaged in business or loan transactions with anyone outside of the family.”[42] Also, the FLP distributed cash to Mr. Thompson on several occasions when he desired money for personal purposes. On these facts, the Third Circuit concluded that “an implied agreement [existed] at the time of the transfer that decedent would retain enjoyment and economic benefit of the property transferred to the family limited partnership[].”[43] Thus, instead of including Mr. Thompson’s partnership interests in his gross estate, which were valued “by applying a 40% discount rate to the net asset value of the partnerships and corporations for lack of control and marketability,” the court included in his estate the FLP assets themselves under Section 2036(a)(1).[44]
 
    Another case illustrating the power of Section 2036(a) is Strangi v. Commissioner,[45] in which the Tax Court held that under certain circumstances 2036(a)(2) may be invoked to include the assets of an FLP in a decedent’s gross estate. Section 2036(a)(2) “mandates inclusion in the gross estate of transferred property with respect to which the decedent retained the right to designate the persons who shall possess or enjoy the property or its income.”[46] The Strangi court held that this section applies if the transferor owns a GP interest in an FLP and thus holds the right to determine distributions or to dissolve the partnership, whether alone or in conjunction with others. The Strangi holding has been the topic of much controversy. On appeal, the Fifth Circuit affirmed the Tax Court's decision on other grounds and did not reach the Section 2036(a)(2) issue.[47]
 
  B. The Bona Fide Sale Exception
 
    The effects of Section 2036(a) may be avoided altogether if property is transferred to an FLP in a “bona fide sale for an adequate and full consideration in money or money's worth.”[48] The rationale behind this bona fide sale exception to 2036(a) is that such transfers do “not deplete the gross estate.”[49] If the value of the consideration is “roughly equivalent”[50] to the value of the transferred property, then the estate is replenished and the need to include the transferred property in the gross estate is altogether obviated, even if the transferor retains control over the transferred property. An estate hoping to qualify for this exception must establish two elements: (1) the transfer must be bona fide, and (2) the transfer must be for adequate and full consideration in money or money’s worth.[51]
 
    1. The bona fide sale prong
 
      Courts have applied two separate standards in determining whether a transfer to an FLP constitutes a bona fide sale.
 
      The good faith standard. The Third and Fifth Circuits have applied a “good faith transfer” standard in evaluating this prong.[52] The Regulations define a bona fide sale as a transfer “made in good faith.”[53] A good faith transfer is one in which “the transferor actually part[s] with the . . . interest and the transferee actually part[s] with the requisite adequate and full consideration.”[54] A transfer to an FLP is not made in good faith if the transferor’s relationship to her assets does not change, or in other words, if the transfer results in “a mere recycling of value.”[55] The good faith requirement thus serves to prevent sham transactions and disguised gifts from qualifying for the bona fide sale exception.
 
      The Third and Fifth Circuits have weighed several factors in scrutinizing whether a transfer to an FLP in exchange for a partnership interest is a transfer made in good faith. The most important factor is whether the transfer “provide[s] the transferor some potential for benefit other than the potential estate tax advantages that might result from holding the assets in partnership form.”[56] If a transfer to an FLP is “motivated solely by tax planning,” then the sale is not bona fide, even if all the “i’s are dotted and the t’s are crossed.”[57] When an FLP is created for a genuine non-tax purpose, the transferor’s relationship to her assets is altered, which consummates the transferor’s good faith parting with her interest in the transferred property.[58]
 
      Other factors evaluated under the first prong include: (1) whether partnership formalities are satisfied, including the assignment of assets to the FLP; (2) whether the partnership assets are used for personal expenses; (3) whether the transferor retained sufficient assets for her support so that she need not rely on FLP assets to maintain her standard of living; and (4) whether partnership funds are commingled with personal funds.[59]
 
      The arm’s length standard. Unlike the Third and Fifth Circuits, which have defined a bona fide sale as “a transfer made in good faith,” the Tax Court has equated a bona fide sale with an “arm’s length transaction.”[60] An arm’s length transaction is a transaction involving “meaningful negotiation or bargaining [between] anticipated interest holders.”[61] The test of whether a transaction is arm’s length involves questioning whether “the transaction [was] carried out in the way that the ordinary parties to a business transaction would deal with each other.”[62]
 
      The courts have held that family members can enter into an arm’s length transaction.[63] When applying heightened scrutiny to family transactions, the most important factor weighed by the Tax Court is the presence of genuine business purpose motivating the transaction.[64] The Tax Court also looks to whether the anticipated interest-holders bargained or negotiated over partnership structure, operation, or capitalization.[65] Arm’s length bargaining may be proven by showing that each “member of the family was represented by his or her own independent counsel and had input into the decision-making.”[66] If, however, the transferor, “independently of any other anticipated interest-holder,” determines how the FLP is to be structured, operated, and capitalized, then it may be difficult to prove an arm’s length transaction occurred.[67] As the Tax Court noted, “[i]t would be an oxymoron to say that one can engage in an arm's-length transaction with oneself.”[68] Also, an intra-family transaction may be considered arm’s length where its terms resemble the terms of a transaction between unrelated persons acting in the ordinary course of business.[69]
 
      Another factor that is integral to an arm’s length transaction is the absence of donative intent. When two parties meaningfully negotiate the terms of a transaction at arm’s length, the resultant arrangement will not involve any intent to make a gift.[70] It still may be true in an arm’s length transaction that one party obtains a better deal than the other, but this occurs as a result of superior bargaining leverage or ability rather than donative intent.
 
      In addition to requiring a transaction to be arm’s length, as part of the bona fide sale prong the Tax Court also scrutinizes whether the transaction involves a good faith transfer. Thus, the Tax Court considers whether the FLP is formed for a genuine business purpose, whether the transfer of property to an FLP results in a mere “recycling” of value, and whether the transferor’s relationship to her assets changes.[71] In essence, the arm’s length transaction standard, as applied by the Tax Court, incorporates the good faith standard employed by the Fifth and the Third Circuits.[72] Because it incorporates both of these elements into the first prong of the bona fide sale exemption, the arm’s length standard is a much higher hurdle for taxpayers to overcome than the good faith standard.
 
    2. The adequate and full consideration prong
 
      The second prong of the bona fide sale exception requires that the transfer of property to the FLP be for “adequate and full consideration in money or money’s worth.”[73] The consideration received in exchange for a transfer of property to an FLP is either a GP interest or an LP interest, or some combination of both. “In order for the sale to be for adequate and full consideration, the exchange of assets for partnership interests must be roughly equivalent so the transfer does not deplete the estate.”[74]
 
      The Stone rule. The source of the current, predominant rule for determining whether a transfer of property to an FLP is for adequate and full consideration is the Tax Court’s opinion in Estate of Stone v. Commissioner. In Stone, an elderly couple, Mr. and Mrs. Stone, created five FLPs for the purpose of allowing their children to manage their assets, which included a manufacturing business. The Stones also formed the FLPs to prevent future litigation among the children, who already had an extensive history of litigating issues involving their parent’s assets. After holding that the formation of these partnerships was completed via an arm’s length transaction, the Tax Court explained that the transfer was also for adequate and full consideration based on two considerations. First, all the partners received partnership interests proportionate to the respective value of property they contributed, and capital accounts were credited accordingly, with liquidating distributions to be made in accordance with capital accounts.[75] And second, the partnerships were formed for a genuine business purpose.[76] Under these circumstances, the court concluded that the Stones “received in exchange for their respective transfers of assets to each such partnership respective partnership interests in each such partnership that were adequate and full equivalents reducible to a money value.”[77]
 
      The Fifth Circuit in Kimbell adopted part of the Stone rule in its analysis of the adequate and full consideration prong. The Fifth Circuit, like the Tax Court, held that in determining if a transfer to an FLP is for adequate and full consideration, the proper focus is whether the transferor received a partnership interest proportionate to the value of the transferred property, whether the fair market value of the transferred assets was credited to the transferor’s capital account, and whether liquidating distributions were to be in proportion to capital accounts.[78] However, the Fifth Circuit did not adopt the Stone requirement that the transfer be motivated by a genuine business purpose as part of the adequate and full consideration analysis. Thus, regarding the second prong, like the first, the Fifth Circuit rule is more taxpayer friendly than the Tax Court rule.[79]
 
    3. The Estate of Bongard decision
 
      In March of 2005, the Tax Court, in Estate of Bongard v. Commissioner,[80] formulated a “new” rule specifically for applying the bona fide sale exception to FLPs. The Tax Court conducted a lengthy summary of recent case law dealing with the application bona fide sale exception to FLPs and concluded:
 
        In the context of family limited partnerships, the bona fide sale for adequate and full consideration exception is met where the record establishes the existence of a legitimate and significant nontax reason for creating the family limited partnership, and the transferors received partnership interests proportionate to the value of the property transferred.[81]
 
      After stating this rule, the court proceeded to analyze the transfers in question under the traditional two-prong test. The Tax Court's “new” rule focused additional attention on the issue of a genuine business purpose, but beyond that, it did little to substantively alter the court’s bona fide sale analysis. If anything, it demonstrated the court’s confusion over the proper framework for analyzing the bona fide sale exception.
 
      At issue in Bongard were two separate transactions involving the decedent and his family members. In the first transaction, the decedent formed a holding company and the members of his family transferred all of their stock in a family-owned corporation to the holding company. The Tax Court held that this transfer satisfied both the bona fide sale prong and the adequate and full consideration prong, and thus qualified for the bona fide sale exception. The evidence established that the genuine business purpose of the transaction was to better position the family company for a corporate liquidity event. Because the transfer was undertaken for a legitimate and significant nontax reason and because the terms of the transaction did not differ “from those of two unrelated parties negotiating at arm’s length,” the court held that it was an arm’s length transaction.[82] The Tax Court also found that the transfer was a bona fide sale because it “resulted in a true pooling of assets.”[83] These two findings fulfilled the requirements of the Tax Court’s arm’s length standard for the first prong of the bona fide sale exception. The court then held that the second prong of the exception was satisfied, applying the Stone rule.[84] Having found that the transfer of stock to the holding company was bona fide and for adequate and full consideration, the court concluded that it qualified for the bona fide sale exception.
 
      However, the Tax Court was not so friendly toward the second transaction, in which the decedent transferred some of the holding company membership units to an FLP. The court found no business purpose motivating this transfer. The FLP did not diversify its holdings, perform any management function, or enter into any businesslike transaction. On these facts, the Tax Court held that the transfer of membership units to the FLP was merely a recycling of value that lacked any legitimate and significant nontax business purpose and as a result did not qualify for the bona fide sale exception.[85]
 
      In substance, the legitimate and significant nontax reason rule, as applied by the Tax Court in Bongard, adds little to the Tax Court’s traditional analysis of the bona fide sale exception set forth in Stone. In Bongard, even after stating its “new” rule, the Tax Court still applied the same two-prong test that it used in Stone, and both of those prongs already incorporated a legitimate business purpose element.[86] Moreover, to support a finding of a legitimate and significant business purpose, the Tax Court weighed the same factors that it weighed under the arm’s length transaction standard. The court stated:
 
        A list of factors that support such a finding includes the taxpayer standing on both sides of the transaction; the taxpayer's financial dependence on distributions from the partnership; the partners' commingling of partnership funds with their own; and the taxpayer's actual failure to transfer the property to the partnership.[87]
 
    The first of these factors is part of the arm’s length inquiry. The last three factors are part of the bona fide inquiry. Thus, the legitimate and significant nontax reason standard applied by the Bongard court is nothing more than a rearrangement of the Tax Court’s arm’s length standard, with extra emphasis placed on the genuine business purpose factor. The Bongard court’s creation of a “new” rule demonstrates the confusion that exists over the proper standard for determining when the bona fide sale exception applies to FLPs. The fact that the Tax Court went to the effort of attempting to define a new rule shows that it was not content with the arm’s length standard it had applied previously. Moreover, the fact that the new rule, for the most part, simply emphasizes the key element of the old standard illustrates that the court is struggling to identify the key, underlying issues in applying the bona fide sale exception.
 
    4. The Estate of Bigelow decision
 
      Two weeks after releasing the Bongard opinion, the Tax Court issued another opinion, Estate of Bigelow v. Comm’r,[88] that serves as a useful illustration of how the court plans to apply the Bongard rule. In Bigelow, an elderly woman transferred a personal residence that operated as a rental property from her revocable trust to an FLP, but she left the debt that accompanied the transferred property in the trust. Soon thereafter, having relinquished the income generated by the residence, the woman found herself with insufficient funds to repay the retained loans and meet her other financial obligations. The FLP stepped in and began to make payments on the loans for her, which led the court to conclude that there was an implied agreement that she would retain the economic benefit of the transferred property.[89]
 
      In its statement of the rule governing the bona fide sale exception, the Tax Court cited Thompson and noted, “[t]o constitute a bona fide sale for adequate and full consideration, the transfer of the property must be made in good faith.”[90] The court then explained, “such a sale requires that the transfer be made for a legitimate nontax purpose.”[91] The court proceeded to hold that the transfer in question was not a good faith transfer because the transferor failed to retain sufficient assets to meet her financial obligations, because the FLP did not maintain capital accounts in accordance with the terms of the partnership agreement, and because the transfer to the FLP offered the transferor no potential for benefit other than tax savings.[92]
 
      The Bigelow opinion merits three observations. First, Bigelow illustrates that the legitimate and significant nontax requirement is merely an element (albeit an essential element) of a good faith transfer rather than a new, independent requirement for the bona fide sale exception. Second, Bigelow demonstrates that the legitimate and significant nontax requirement is not the only element of a good faith transfer, but one of several factors that courts should consider. Third, the Bigelow opinion is peculiar in the standard that the court chose to apply. The Tax Court diverged from its history of applying the arm’s length standard, choosing instead to apply the good faith standard. It could be argued that the Tax Court wavered in its application of the arm’s length standard in the face of two circuit court opinions holding that an arm’s length transfer is not an essential element of a bona fide sale for adequate and full consideration.[93] However, it is more likely that the court applied the good faith standard because a transfer that does not meet the good faith standard cannot qualify under the more stringent arm’s length standard. Under this view, after Bigelow the arm’s length standard is still good law outside the Third and Fifth Circuits.
 
      The confusion among the courts over the proper standard is understandable considering the conceptual difficulty associated with finding that a partnership interest valued at a discount from net asset value constitutes adequate and full consideration for the transfer of assets to an FLP. The cause of this confusion, as discussed below, is the Tax Court’s failure to recognize the proper justification for applying the bona fide sale exception to transfers in exchange for discounted partnership interests.
 

IV.

Analysis: The Proper Rationale for a Finding of Adequate and Full Consideration

 
  In March of 2005, in separate concurring opinions in Estate of Bongard, Judge Laro and Judge Halpren explained that there are two possible justifications for applying the bona fide sale exception. The traditional rationale is that the bona fide sale exception may be applied when the value of the consideration equals the value of the transferred property, thus replenishing the estate. The second rationale is that when a transaction occurs in the ordinary course of business, courts may presume that there is adequate and full consideration in money or money’s worth.[94]
 
  Courts have struggled to conceptually fit a transfer to an FLP in exchange for a discounted partnership interest into the framework of the first of these justifications. This is because the value of a discounted partnership interest will never, due to the valuation discount, equal the value of the property transferred to an FLP, and thus will never replenish the estate. Thus, in the context of transfers of property to an FLP, only transfers made in the ordinary course of business should qualify for the bona fide sale exception. When a transfer is made in the ordinary course of business, courts should simply presume that the transfer is for adequate and full consideration. Recognizing the proper justification for applying the bona fide sale exception to FLPs is imperative in order to eliminate confusion over the proper standard for determining when the exception should apply to FLPs.
 
  A. Dollar for Dollar Replenishment
 
    In several recent FLP cases, the Service has argued that it is inconsistent for an estate to argue, on one hand, that a decedent’s interest in an FLP qualifies for a substantial discount and, on the other hand, that the partnership interest qualifies as adequate and full consideration for the transfer of assets to the FLP.[95] This inconsistency argument has definite appeal—if a taxpayer transfers $1,000 to an FLP in exchange for a partnership interest discounted by 35 percent and thus valued at $650, it would seem that the FLP interest could never constitute adequate and full consideration. Despite the logical simplicity of this argument, no court has found this argument persuasive, but neither has any court presented a compelling reason why this argument must fail.
 
    The Tax Court in Stone, for example, explained that the argument that a discounted partnership interest can never constitute adequate and full consideration improperly reads the bona fide sale exception out of Section 2036(a).[96] However, the Stone court did not explain how it improperly read the exception of Section 2036(a), nor did it provide any other support for its rejection of the Service’s inconsistency argument.[97] Rather, the Stone court held that receipt of a partnership interest proportional to the value of the transferred property could constitute adequate and full consideration. Proportionality, however, does not ensure that the estate is replenished and thus is an insufficient test as to whether consideration is adequate and full.[98]
 
    The Fifth Circuit in Kimbell attempted to respond to the Service’s inconsistency argument by holding that intangible considerations make up for the difference in value between the transferred property and the partnership interests. The court reasoned that there are “financial considerations other than the ability to turn right around and sell the newly acquired limited partnership interest for 100 cents on the dollar” that motivate a transferor to use an FLP.[99] As examples of such financial considerations, the court listed, “management expertise, security and preservation of assets, capital appreciation and avoidance of personal liability.”[100] The court continued:
 
      Thus there is nothing inconsistent in acknowledging, on the one hand, that the investor's dollars have acquired a limited partnership interest at arm's length for adequate and full consideration and, on the other hand, that the asset thus acquired has a present fair market value, i.e., immediate sale potential, of substantially less than the dollars just paid--a classic informed trade-off.[101]
 
    The Fifth Circuit thus implicitly argued that a transfer to an FLP is for adequate and full consideration when the sum of the value of the discounted partnership interests and the value of the intangible economic benefits received from utilizing the partnership form equals the value of the property transferred to the partnership. The Tax Court also implicitly advanced this argument in Estate of Harper, when it stated, “there is at least the potential that intangibles stemming from a pooling for joint enterprise might support a ruling of adequate and full consideration.”[102]
 
    The argument that intangibles help give rise to a finding of adequate and full consideration fails to take into account two limitations on a court’s freedom to consider such intangible economic benefits when valuing consideration received in exchange for a transfer of property. The first limitation is the fair market value standard, which allows only intangibles that would be of value to the hypothetical buyer to be considered. The second is the statutory requirement that the consideration be in money or money’s worth.
 
    1. Limitations imposed by the fair market value standard
 
      The correct standard for valuing property for purposes of the bona fide sale exception is the fair market value standard. The Treasury Regulations clearly explain that the fair market value standard is the proper standard for valuing “property includible in a decedent’s gross estate” and for valuing taxable gifts.[103] However, Section 2036(a) consideration does not fit into either of these two categories, and as a result, the Regulations do not indicate the correct standard for valuing such consideration. The Tax Court and the Ninth Circuit, however, have filled the gap, holding that the fair market value standard is still applicable when determining the value of consideration received in the context of Section 2036.[104]
 
      Under the fair market value standard, only those intangibles that have value to the hypothetical, unrelated buyer or seller may be considered when valuing the 2036(a) consideration. The intangible benefits listed by the Fifth Circuit—“management expertise, security and preservation of assets, capital appreciation and avoidance of personal liability”[105]—would all potentially have value in the eyes of an unrelated buyer and thus could be considered. However, the Fifth Circuit’s list was noninclusive, and many of the other intangibles that might motivate a transferor to contribute property to an FLP would not have any value to the unrelated buyer.[106] Due to this limitation, in order for the adequate and full consideration requirement to be met, the value of those intangibles which are subject to fair market valuation by itself must be equal to the discount claimed by the taxpayer on the partnership interest. This makes it more difficult for a discounted partnership interest and the accompanying intangibles to fully replenish the estate.
 
      Perhaps recognizing the effect of this limitation, the Fifth Circuit, in Kimbell, errantly held that the fair market value standard is not the proper means of valuing consideration received for purposes of the bona fide sale exception.[107] The Kimbell court did not attempt to justify its rejection of the fair market value standard, and it also failed to suggest an alternative standard. The Fifth Circuit’s unsupported holding on this issue flies in the face of the purpose of the bona fide sale exception as well as contradictory (albeit nonbinding) Tax Court and Ninth Circuit authority.
 
      The Tax Court’s and the Ninth Circuit’s holdings that the fair market value standard is the appropriate standard is the superior position. The purpose of the bona fide sale exception is to disengage Section 2036(a) when consideration for a transfer of property replenishes the estate.[108] In light of this purpose, the fair market value standard is the only appropriate standard for valuing consideration to determine whether it is adequate and full. Because transferred property pulled back into the gross estate by Section 2036(a) will be valued under the fair market value standard upon the transferor’s death, reliable assurance that the estate has been replenished can only be obtained by applying the same standard to the consideration received.[109] To use any other standard would be to compare apples and oranges.[110]
 
    2. Limitations imposed by the money or money’s worth requirement
 
      In addition to the limitation on valuing intangibles imposed by the fair market value standard, the requirement that consideration be in money or money’s worth further limits the valuation of intangibles. The bona fide sale exception applies “in case of a bona fide sale for an adequate and full consideration in money or money’s worth.”[111] The Treasury Regulations explain that consideration “in money or money’s worth” is consideration that is “reducible to a money value.”[112] As examples of consideration that is not reducible to a money value, the Regulations list “love and affection, promise of marriage, etc.”[113] Such consideration is to be “wholly disregarded.”[114] However, consideration in money or money’s worth does include “tangible or intangible property, services, and other consideration reducible to a money value.”[115]
 
      The money or money’s worth requirement imposes an additional limitation on the valuation of intangible benefits. Some intangible benefits that might motivate a taxpayer to use the FLP structure—such as involving the children in the management of property—may not be reducible to a money value. In valuing a partnership interest, an appraiser must consider “[a]ll relevant facts and data,”[116] which includes intangible benefits associated with the partnership interest.[117] Thus, inasmuch as intangible benefits such as “management expertise, security and preservation of assets, capital appreciation and avoidance of personal liability”[118] are reducible to a money’s value, their value should already be reflected in the appraised value of the partnership interest. The fact that an appraisal of an interest in an FLP still comes in at a significant discount from net asset value evidences that the value of the intangibles is insufficient to help replenish the estate. Either because they are not relevant to the hypothetical buyer and seller, or because they are not reducible to a money’s value, the value of intangible benefits fails to support a finding of adequate and full consideration.[119]
 
      The money or money’s worth requirement must be enforced to fulfill the requirement that a statute be interpreted so as to “give effect to all of its parts.”[120] Also, the money or money’s worth requirement is essential to fulfilling the purpose of the bona fide sale exception. Absent this requirement, there is no assurance that the transfer of property to an FLP does not deplete the estate.
 
      Therefore, when the restraints imposed by the fair market value standard and the money or money’s worth requirement are considered, it is extremely difficult, even impossible, to support the argument implicitly advanced by the Fifth Circuit and the Tax Court that the value of intangible benefits can give rise to a finding that a discounted partnership interest constitutes adequate and full consideration. Indeed, a transfer to an FLP for a discounted partnership interest cannot qualify for the bona fide sale exception on the grounds that the consideration sufficiently replenishes the estate. However, this does not lead to the extreme conclusion asserted by the concurrence in Thompson that whenever a partnership interest qualifies for a valuation discount, “the decedent could not have received and adequate and full consideration for his transfers in terms of ‘money’s worth.’”[121]
 
  B. A Presumption of Adequate and Full Consideration.
 
    The second rationale for justifying a finding of adequate and full consideration does not suffer the same fate as the first in the context of discounted partnership interests. When a transfer of property is made to an FLP in the ordinary course of business, courts should presume that it was made for adequate and full consideration in money or money’s worth. In the case of discounted partnership interests, whose dollar value will never rise to the value of the transferred property, this presumption is the only means of holding that such interests constitute adequate and full consideration in money or money’s worth.
 
    The gift tax Treasury Regulations provide that “a transfer of property made in the ordinary course of business (a transaction which is bona fide, at arm’s length, and free from any donative intent), will be considered as made for an adequate and full consideration in money or money’s worth.”[122] There is thus a presumption under the gift tax regime that consideration received in a transaction entered into in the ordinary course of business constitutes adequate and full consideration in money or money’s worth under the fair market value standard.[123] This presumption also applies to Section 2036 because the phrase “adequate and full consideration” is construed the same for both the estate and gift tax purposes.[124]
 
    This presumption serves to qualify certain discounted partnership interests for the bona fide sale exception because when a transfer to an FLP is shown to be in the ordinary course of business, “the inquiry as to full consideration is avoided (and the actual fair market value of the consideration given for the transferred property is irrelevant).”[125] Thus, for a transfer in the ordinary course of business, it does not matter that the discounted partnership is worth less than the transferred property, nor does it matter that the estate has not been fully replenished. With transactions in the ordinary course of business, the purpose of ensuring that the estate is replenished is superceded by the desire not to “impede the socially important goal of encouraging accumulation of capital for commercial enterprises.”[126]
 
    However, the presumption of adequate and full consideration is justifiable only where the transaction in question is truly in the ordinary course of business—meaning “bona fide, at arm’s length, and free from any donative intent.”[127] Transfers of property between family members require heightened scrutiny to ensure that substance is congruent with form. This requires rebutting the presumption that intra-family transactions are not arm’s length transactions.[128] Thus, the presumption of adequate and full consideration should only be applied where the evidence establishes that the transferors acted in their own self-interest, in a manner similar to unrelated parties operating in the ordinary course of business.
 
    No court has relied upon the presumption of adequate and full consideration rationale in support of a finding that the bona fide sale exception has been met,[129] but the Tax Court rule incorporates nearly all of the elements necessary to apply the presumption. Unfortunately, the failure to recognize the role of the presumption of adequate and full consideration has led to substantial confusion in the Tax Court and in the circuit courts concerning the proper standard for the bona fide sale exception.
 
  C. The Correct Statement of the Rule
 
    When the proper justification for holding that a discounted partnership qualifies for the bona fide sale exception is recognized, it is simple to state the exact standard that should be applied. Courts should presume a transfer of property to an FLP is for adequate and full consideration when the transfer is made in the ordinary course of business. Thus, the proper test is whether the transfer in question is made in the ordinary course of business, which requires proving that the transaction is (1) bona fide, (2) at arm’s length, and (3) free from any donative intent.[130] Once these three elements are shown, courts need not inquire any further as “the actual fair market value of the consideration given for the transferred property is irrelevant.”[131]
 
    1. The Tax Court standard closely approximates the ordinary course of business standard.
 
      The ordinary course of business standard is quite similar to the Tax Court’s arm’s length standard. The arm’s length standard applied by the Tax Court in evaluating the first prong of the bona fide sale exception already involves an inquiry into whether the transfer in question is bona fide and at arm’s length.[132] Thus, the only additional requirement imposed by the ordinary course of business test is that there be no donative intent motivating the transfer. This element is closely related to the arm’s length requirement—in fact, it could be argued that finding a transaction is arm’s length necessarily includes a finding that it was not motivated by donative intent.[133] Nevertheless, to explicitly comply with the requirements of the Regulations, courts should include a separate finding regarding donative intent in their bona fide sale exception analysis.
 
      Also, under the ordinary course of business standard, there is no need to delve into an analysis of the second prong of the bona fide sale exception. The adequacy of consideration is simply presumed.[134]
 
      Finally, the ordinary course of business standard encompasses the Tax Court’s legitimate and significant nontax purpose rule enunciated in Bongard. Both the bona fide element and the arm’s length element require an inquiry into whether the transfer in question was motivated by a legitimate business purpose. The importance of this factor in both the bona fide and the arm’s length elements essentially guarantees that no transaction will ever qualify as a transaction in the ordinary course of business unless it is motivated by a genuine business purpose.
 
    2. The Fifth and Third Circuit standards are too lenient
 
      Under the good faith standard applied by the Third and Fifth Circuits, to qualify for the bona fide sale exception, a contribution to an FLP must be a good faith transfer and the partnership interests received in exchange must be proportionate to the fair market value of the transferred property.[135] In these circuits, there is no requirement that the transfer be arm’s length or free from any donative intent. The Third and Fifth Circuits developed the good faith standard operating under the framework of trying to show how a discounted partnership interest can somehow constitute adequate and full consideration. As demonstrated above, this rationale does not hold water.[136] The only proper way to justify applying the bona fide sale exception to a transfer in exchange for a discounted partnership interest is by presuming that adequate and full consideration exists, and this presumption is only appropriate where the transfer is in the ordinary course of business. For this reason, the standard applied by the Fifth and Third Circuits fails to require the necessary level of scrutiny to transfers of property to an FLP.
 

V.

Conclusion

 
  The FLP potentially offers taxpayers substantial transfer tax savings in the form of valuation discounts for lack of control and lack of marketability. Under the fair market value standard, these discounts are entirely appropriate and justifiable. However, when taxpayers use FLPs as testamentary vehicles with little accompanying business purpose, the availability of tax savings resulting from these discounts should be curtailed. Recognizing this, courts have been quite willing over the past few years, when appropriate, to bring property transferred to an FLP back into the decedent’s gross estate using Section 2036(a). But courts should be wary of an overly liberal application of the bona fide sale exception that could negate the effectiveness of Section 2036(a).
 
  The general failure to recognize the proper justification for applying the bona fide sale prong has led to confusion among courts concerning the correct standard for evaluating transfers of property to an FLP. The bona fide sale exception cannot be applied to a transfer to an FLP on the grounds that the discounted partnership interest received in return replenishes the estate dollar for dollar. Instead, the exception should only be applied to discounted interests received in exchange for a transfer to an FLP in the ordinary course of business. When a transaction is entered into in the ordinary course of business—that is when the transfer is both bona fide, at arm’s length, and free from donative intent—courts may presume that the transferor received adequate and full consideration in money or money’s worth. Because this presumption is the only proper justification for holding that the bona fide sale exception applies to transfers to an FLP, only transactions entered into in the ordinary course of business should be excepted from the reach of Section 2036(a) as bona fide transfers for adequate and full consideration.
 
Copyright 2005. Layne T. Smith. All rights reserved.
 
[1] Susan Kimsey Smith, "Bulletproofing Family Limited Partnerships and Limited Liability Companies," ALI-ABA Est. Plan. Course Materials J., Dec. 2004, at 45, 45–46.
 
[2] S. Stacy Eastland, New Tax Court Cases: Developments in Plannning with Family Limited Partnerships, 29 ACTEC J. 69, 81–91 (2003); Michael D. Mulligan, Courts Err in Applying Section 2036(a)(2) to Limited Partnerships, 30 Est. Plan. 486, 490–94 (2003); Mitchell M. Gans, Strangi: A Critical Analysis and Planning Suggestions, 330 PLI/EST. 727 (2003).
 
[3] Ronald H. Jensen, The Magic of Disappearing Wealth Revisited: Using Family Limited Partnerships to Reduce Estate and Gift Tax, 1 PITT. TAX. REV.
 
[4] Id., at 192 (discussing the need for reform of the transfer tax law governing FLPs).
 
[5] I.R.C. § 2036 (2000).
 
[6] 371 F.3d 257 (5th Cir. 2004).
 
[7] 124 T.C. No. 8 (2005).
 
[8] See, e.g., Estate of Stone v. Comm’r, 86 T.C.M. (CCH) 551, 579 (2003) (allowing a 43 percent valuation discount). But see Stephen T. Black & Michael D. Black, When a Discount Isn’t a Bargain: Debunking the Myths Behind Family Limited Partnerships, 35 UWLA L. REV. 302 (2003).
 
[9] Treas. Reg. §§ 20.2031-1(b); 25.2512-1.
 
[10] Treas. Reg. § 20.2031-1(b).
 
[11] Jensen, supra note 3, at 169.
 
[12] Kenneth P. Brier & Joseph B. Darby, III, Family Limited Partnerships: Decanting Family Investment Assets into New Bottles, 49 TAX LAW. 127, 129 (1995).
 
[13] Jensen, supra note 3, at 167–68.
 
[14] In the 1980s and early 1990s, the Service unsuccessfully attacked the proposition that minority interests in family-controlled businesses should not qualify for discounts for lack of marketability and lack of control. Brier & Darby, supra note 12, at 131–132 (discussing Estate of Watts v. Comm’r, 51 T.C.M. 60 (CCH) (1985), aff'd, 823 F.2d 483 (11th Cir. 1987), and Estate of Harrison v. Comm’r, 52 T.C.M. 1306, 1307 (CCH) (1987)).
 
[15] Jensen, supra note 3, at 170 (describing potential nontax reasons a taxpayer would transfer property to an FLP knowing that the interests received will be valued at a discount).
 
[16] See Kimbell v. United States, 371 F.3d 257, 266 (5th Cir. 2004); S. Stacy Eastland, Family Limited Partnerships: Non-transfer Tax Benefits, 7 Prob. & Prop. 10 March–April 1993.
 
[17] Jensen, supra note 3, at 172–73.
 
[18] Id. at 158–59.
 
[19] Jensen explains,
 
  [In year one] F and M each make gifts of $177,666 to each child and grandchild, resulting in total gifts by each donor of $1,065,996. These gifts are not taxable because of the gift tax unified credit that shelters $1,000,000 from tax in the case of each donor and each donor's annual gift tax exclusion of $11,000 per donee. [$1,000,000 + ($11,000 x 6 donees) = $1,066,000]. The combined gifts of F and M during Year 1 amount to $2,131,992.
 
  [In years two through five] F and M each make gifts of $11,000 to each child and grandchild during each year in this period, resulting in total gifts by each donor of $264,000 [$11,000 per year x 6 donees x 4 years]. These gifts are sheltered from tax by reason of the annual exclusion. The combined gifts of F and M during Years 2-5 amount to $528,000.
 
  [In year six] F and M each make gifts of $9,334 to each child and grandchild, resulting in total gifts during Year 6 of $112,008 [2 donors x $9,334 per donee x 6 donees]. Assuming that the values have remained constant over the six year period, F and M will have completely divested themselves of LP interests. The gifts in Year 6 are completely sheltered from gift tax by the annual exclusion.
 
  Id. at 159–60.
 
[20] This number is obtained by multiplying the value of the LP interests (99 percent of $4,000,000) by the amount of the valuation discount (30 percent).
 
[21] Black, supra note 8, at 315.
 
[22] Kimbell, 371 F.3d at 263.
 
[23] Estate of Thompson v. Comm’r, 382 F.3d 367, 382 (3d Cir. 2004) (quoting Comm’r v. Culbertson, 337 733, 746 (1949)).
 
[24] Estate of Bongard v. Commissioner, 124 T.C. No. 8, at 39 (2005).
 
[25] Id. at 51 (finding that an FLP did not have a legitimate business purpose where it “never diversified its assets during decedent's life, never had an investment plan, and never functioned as a business enterprise or otherwise engaged in any meaningful economic activity”); see also Susan Kalinka, Individuals and Passthrough Entities, 83 Taxes: The Tax Magazine 19, 28 (Jan. 2005).
 
[26] John F. Ramsbacher, FLP’s LLC’s and S corporations: Is It Worth the Effort? Valuation Discount Strategies-Do They Still Work?, 532 PLI/Est. 175, 179 (2003).
 
[27] See e.g., Bongard, 124 T.C. No. 8, at 54–55 (scrutinizing and ultimately rejecting the FLP’s claimed purposes of facilitating a gifting program and creditor protection).
 
[28] Kalinka, supra note 25, at 28.
 
[29] Id.
 
[30] See Jensen, supra note 3, at 184–85.
 
[31] Kalinka, supra note 25, at 28.
 
[32] Estate of Reichardt v. Comm’r, 114 T.C. 144, 152 (2000); Estate of Schauerhamer v. Comm'r, 73 T.C.M. (CCH) 2855, 2857–88 (T.C. 1997).
 
[33] See Harper v. Comm’r, 83 T.C.M. (CCH) 1641, 1650 (2002); Estate of Thompson v. Comm’r, 84 T.C.M. (CCH) 374, 386–87 (2002).
 
[34] Kalinka, supra note 25, at 28.
 
[35] Joan B. Di Cola, Family Limited Partnerships and Limited Liability Companies: General Estate Planning Issues, 84 Mass. L. Rev. 61, 67 (1999). If personal use property is placed in an FLP, the partnership should charge family members a reasonable rent for its use. Kalinka, supra note 25, at 28
 
[36] See Jensen, supra note 3, at 183.
 
[37] 26 U.S.C. § 2036(a) (2000).
 
[38] Kimbell v. United States, 371 F.3d 257, 261 (5th Cir. 2004).
 
[39] U.S. v. Estate of Grace, 395 U.S. 316, 320 (1969).
 
[40] Treas. Reg. § 20.2036-1(a).
 
[41] 382 F.3d 367 (3d Cir. 2004).
 
[42] Id at 377.
 
[43] Id.
 
[44] Id.
 
[45] 85 T.C.M. (CCH) 1331 (2003).
 
[46] Id. at 1340.
 
[47] Strangi v. Comm’r, 2005 WL 1660817 n. 7 (2005).
 
[48] 26 U.S.C. § 2036(a) (2000). The bona fide sale exception also exempts taxpayers from the provisions of several other estate and gift tax provisions, e.g., I.R.C. §§ 2037, 2038, 2512.
 
[49] Estate of Bongard v. Comm’r, 124 T.C. No. 8, at 66–67 (Laro, J. concurring) (citing cases that emphasize the importance of replenishing the estate in applying the bona fide sale exception).
 
[50] Kimbell v. United States, 371 F.3d 257, 262 (5th Cir. 2004).
 
[51] Id. at 261.
 
[52] Id. at 263; Estate of Thompson v. Comm’r. 382 F.3d 367, 382 (3d Cir. 2004).
 
[53] Treasury Regulation §§ 20.2036-1(a), 20.2043-1(a); see also Kimbell, 371 F.3d at 263; Thompson, 382 F.3d at 382.
 
[54] Wheeler v. United States, 116 F.3d 749, 764 (5th Cir. 1997); Kimbell, 371 F.3d at 265; Thompson, 382 F.3d at 382.
 
[55] Kimbell, F.3d at 263; see also Strangi v. Comm’r, 85 T.C.M. (CCH) 1331, 1344 (2003) (finding there was no bona fide sale where “all decedent did was to change the form in which he held his beneficial interest in the contributed property”).
 
[56] Thompson, 382 F.3d at 383; see also Kimbell, 371 F.3d at 264.
 
[57] Thompson, 382 F.3d at 383.
 
[58] See Kimbell, 371 F.3d at 264; Kalinka, supra note 25, at 28.
 
[59] See Kimbell, 371 F.3d at 267.
 
[60] Strangi, 85 T.C.M. (CCH) at 1343 (defining the first prong as requiring “a bona fide sale, meaning an arm’s-length transaction”); Harper v. Comm’r, 83 T.C.M. (CCH) 1641, 1653 (2002) (citing Estate of Goetchius v. Comm’r, 17 T.C. 495, 503 (1951) (“[T]he exemption from tax is limited to those transfers of property where the transferor or donor has received benefit in full consideration in a genuine arm's length transaction”).
 
[61] Strangi, 85 T.C.M. (CCH) at 1334.
 
[62] Estate of Bongard v. Comm’r, 124 T.C. No. 8, at 47 (2005) (citing Dauth v. Comm’r, 42 B.T.A. 1181, 1189 (1940)).
 
[63] E.g., Rosenthal v. Comm’r, 205 F.2d 505, 509 (2d Cir. 1953) (“[E]ven a family transaction may for gift tax purposes be treated as one ‘in the ordinary course of business.’”); Bongard, 128 T.C. No. 8, at 47 (noting that “heightened scrutiny is not tantamount to an absolute bar”).
 
[64] E.g. Estate of Stone v. Comm’r, 86 T.C.M. (CCH) 551, 580 (2003) (“[T]he record shows that those transfers were motivated primarily by investment and business concerns relating to the management of certain of the respective assets.”).
 
[65] See, e.g., Strangi v. Comm’r, 85 T.C.M. (CCH) 1331, 1343 (weighing the “absence of any bargaining or negotiation whatsoever” between interest holders in holding there was no arm’s length transaction); Harper, 83 T.C.M. at 1653.
 
[66] Stone, 86 T.C.M. (CCH) at 579. But see Bongard, 124 T.C. No. 8, at 52–53 (finding the fact that an interest holder “was adequately and independently represented in negotiating the terms of the BFLP transaction” to be unpersuasive).
 
[67] Harper, 83 T.C.M. (CCH) at 1653.
 
[68] Id.
 
[69] Bongard, 124 T.C. No. 8, at 47.
 
[70] See Fehrs v. United States, 620 F.2d 255, 260 (Ct. Cl. 1980) (noting that “the possibility of donative intent can be ruled out on the basis of the arm’s length dealings involved and their bona fide business objectives”).
 
[71] See, e.g., Bongard, 124 T.C. No. 8, at 52; Harper, 83 T.C.M. (CCH) at 1652.
 
[72] While these two concepts are distinct, “[a]s a practical matter, an ‘arm’s length’ transaction provides good evidence of a ‘bona fide sale,’ especially within intra-family transactions.” Estate of Thompson v. Comm’r, 382 F.3d 367, 381 (3d Cir. 2004).
 
[73] 26 U.S.C. § 2036(a).
 
[74] Kimbell v. United States, 371 F.3d 257, 265 (5th Cir. 2004).
 
[75] Estate of Stone v. Comm’r, 86 T.C.M. (CCH) 551, 580–81 (2003).
 
[76] Id. at 581 (weighing “the fact that each of the Five Partnerships was created, funded, and operated as a joint enterprise for profit for the management of its assets in which there was a genuine pooling of property and services”).
 
[77] Id.
 
[78] Kimbell, 371 F.3d at 266; Strangi v. Comm’r, 2005 WL 1660817 (5th Cir.).
 
[79] The Third Circuit, in Thompson v. Comm’r, 382 F.3d 367, 381–83 (2004), held that the transfer in question failed the first prong and did not discuss the second prong of the exception.
 
[80] 124 T.C. No. 8 (2005).
 
[81] Id. at 39.
 
[82] Id. at 47–48.
 
[83] Id.
 
[84] The court held that the transfer was for adequate and full consideration because (1) each partner received interests in the holding company in proportion to the number of shares of stock contributed and the capital accounts were structured so as to reflect partnership contributions and distributions, and (2) the transaction was effectuated for a legitimate and significant nontax, business reason. Id. at 49–50.
 
[85] Id. at 51–56. The estate argued that the decedent formed the FLP for creditor protection purposes and to facilitate a gifting program. The court found these purposes to be unpersuasive, concluding instead that estate tax savings motivated the transfer to the FLP. Id. at 53.
 
[86] See supra note 64 and note 76 and accompanying text.
 
[87] 124 T.C. No. 8, at 39–40 (internal citations omitted).
 
[88] T.C. Memo 2005-65 (2005).
 
[89] Id. at 22.
 
[90] Id. at 25.
 
[91] Id.
 
[92] The revocable trust took both a GP and an LP interest in the FLP in exchange for transferring the residence to the FLP. Because the trust was the GP interest holder, the trustee continued to manage the property just as he did before the transfer and the FLP offered the trust no protection against creditors. These facts supported the court’s conclusion that the FLP did not serve a legitimate business purpose. Id. at 26–27.
 
[93] Estate of Thompson v. Comm’r , 382 F.3d 367, 382 (3d Cir. 2004); Kimbell v. United States, 371 F.3d 257, 267 (5th Cir. 2004).
 
[94] Bongard, 124 T.C. No. 8, at 64–65 (Laro, J., concurring); Id. at 86 (Halpren, J., concurring).
 
[95] See, e.g., Kimbell v. United States, 371 F.3d 257, 265 (5th Cir. 2004); Estate of Stone, 86 T.C.M. (CCH) 551, 581 (2003).
 
[96] Stone, 86 T.C.M. (CCH) at 551, 581.
 
[97] See Estate of Thompson v. Comm’r, 382 F.3d 367, 386 (2004) (Greenberg, J., concurring) (criticizing Snow for not explaining why the Service’s argument reads the exception out of Section 2036(a)).
 
[98] Bongard, 124 T.C. No. 8, at 82–83 (Halpren, J., concurring).
 
[99] Kimbell, 371 F.3d at 266.
 
[100] Id.
 
[101] Id.
 
[102] Harper v. Comm’r, 83 T.C.M. (CCH) 1637, 1564 (2002).
 
[103] Treas. Reg. §§ 20.2031-1(b), 25.2512-1.
 
[104] Magnin v. Comm’r, 81 T.C.M. (CCH) 1126, 1130–31 (2001) (“[T]he proper standard to apply in valuing the property interests transferred and received by [the decedent] was the hypothetical willing buyer and willing seller standard.”), aff’d Estate of Magnin v. Comm’r, 184 F.3d 1074, 1081 (9th Cir. 1999).
 
[105] Kimbell v. United States, 371 F.3d 257, 266 (5th Cir. 2004).
 
[106] See supra note 16 and accompanying text.
 
[107] Kimbell, 371 F.3d at 266.
 
[108] See supra notes 48–49 and accompanying text.
 
[109] Estate of Bongard v. Comm’r, 124 T.C. No. 8, at 67 (Laro, J., concurring) (“I believe it only natural to conclude that the same approach should apply to determine the value of the consideration that would have replaced the transferred property in the transferor's gross estate.”).
 
[110] Cf. Kimbell, 371 F.3d 257.
 
[111] I.R.C. § 2036(a) (2000) (emphasis added).
 
[112] Treasury Reg. § 20.2043-1(a).
 
[113] Treasury Reg. § 25.2512-8.
 
[114] Id.
 
[115] Treasury Reg. § 301.6323(h)-1(a)(3) (defining “money or money’s worth” in the context of a security interest).
 
[116] Treas. Reg. § 20.2031-1(b) (1965).
 
[117] Treas. Reg. § 20.2031-3 provides that the fair market value of a business interest should be “determined on the basis of all relevant factors including . . . [a] fair appraisal as of the applicable valuation date of all the assets of the business, tangible and intangible, including good will.”
 
[118] Kimbell v. United States, 371 F.3d 257, 266 (5th Cir. 2004).
 
[119] See Estate of Thompson v. Comm’r, 382 F.3d 367, 384 (5th Cir. 2004) (Greenberg, J., concurring).
 
[120] Estate of Magnin v. Comm’r, 184 F.3d 1074, 1078 (9th Cir. 1999).
 
[121] Thompson, 382 F.3d at 384 (Greenberg, J., concurring).
 
[122] Treas. Reg. § 25.2512-8.
 
[123] See, e.g., Rosenthal v. Comm’r, 205 F.2d 505, 509 (2d Cir. 1953) (“[E]ven a family transaction may for gift tax purposes be treated as one 'in the ordinary course of business' as defined in this Regulation if each of the parenthetical criteria is fully met.”).
 
[124] Merrill v. Fahs, 324 U.S. 308, 311 (1045); Wheeler v. United States, 116 F.3d 749, 761 (5th Cir. 1997).
 
[125] Estate of Bongard, 124 T.C. No. 8, at 79 (Halpbern, J., concurring).
 
[126] Thompson, 382 F.3d at 386 (Greenberg, J., concurring).
 
[127] Treas. Reg. § 25.2512-8.
 
[128] See supra Part II.B.1.
 
[129] The Tax Court did recognize the presumption in one sentence in Harper v. Comm’r:
 
  We also note that section 25.2512-8, Gift Tax Regs., specifies that transfers "made in the ordinary course of business (a transaction which is bona fide, at arm's length, and free from any donative intent), will be considered as made for an adequate and full consideration in money or money's worth.”
 
83 T.C.M. (CCH) 1637, 1654. Other than this statement, the Harper court did not dedicate any analysis to the presumption. Id.
 
[130] Treas. Reg. § 25.2512-8 (1992). In Estate of Bongard, Judge Halpren argued that the test should be “whether the transfer was made in the ordinary course of business, as that term is used in section 25.2512-8, Gift Tax Regs.” Bongard, 124 T.C. No. 8, at 83 (Halpren, J., concurring). In a separate concurring opinion, Judge Laro also advocated a test of whether “the transfer was an ordinary commercial transaction (in which case, the transferred property and the consideration received in return are considered to have the same fair market values).” Id. at 65 (Laro, J., concurring). Judge Laro also advocated a second prong inquiring into whether “the transfer was made with a business purpose.” Id. However, this requirement is redundant because the business purpose element is a key factor in both the bona fide and arm’s length transaction analyses.
 
[131] Bongard, 124 T.C. No. 8, at 79 (Halpren, J., concurring).
 
[132] See supra note 70 and accompanying text.
 
[133] See supra note 69 and accompanying text.
 
[134] Nevertheless, the inquiry in the second prong into whether the transferor received a partnership interest proportional to the value of the property contributed to the FLP is still relevant to the ordinary course of business standard. Specifically, the proportional assignment of partnership interests is the type of term that unrelated potential interest-holders would negotiate in an arm’s length transaction. Bongard, 124 T.C. No. 8, at 82 (Halpren, J., concurring) (“[A]n inquiry as to proportionality may have some bearing on whether the transfer was in the ordinary course of business, within the meaning of section 25.2512-8, Gift Tax Regs. (e.g., was at arm’s length).”). This factor is thus evidence of an ordinary course of business transaction.
 
[135] See supra Part III.B.
 
[136] See supra Part V.A.