Full value of FLP included in estate.
A and E formed a revocable living trust in 1993, contributing their family home, household furnishings, a vacant lot, a money market account, bank accounts and monthly Social Security income. A year later, they created a limited partnership (LP) (KPLP), transferring stocks and bonds for a 98% LP interest. The living trust transferred a savings account for a 2% KPLP general partnership interest.
In 1995, A and E gifted the 98% KPLP interest to four irrevocable trusts created for their sons; each received a 24.5% interest in KPLP. For three years before A and E's deaths in 1998, KPLP made several distributions to the living trust as general partner, as well as a limited number of distributions to the four sons' trusts as limited partners. These payments were used for E's nursing home costs and to pay the couple's taxes, medical bills and other expenses. Payments to the limited partners during the same period were intended to pay their income taxes.
On gift tax returns, A and E claimed a 43% discount on the book value of each gift, because the LP interests were minority interests, their transfer was restricted and they lacked management control. A and E's estate tax returns did not include the value of the assets transferred to KPLP in 1995. The IRS issued deficiency notices to both estates, including the full value of the KPLP assets, on the grounds A and E retained for their lives "the possession or enjoyment of, or the right to the income from, the property" under Sec. 2036. The Tax Court also held that KPLP did not satisfy the Sec. 2036(a) exception for bona fide sales. The taxpayers appealed to the Eighth Circuit.
Sec. 2036 provides in relevant part:
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 ... by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death ... the possession or enjoyment of, or the right to the income from, the property.
Retained rights: We find no clear error in the Tax Court's determination that an implied agreement existed that allowed A and E to retain the right to income from KPLP after its initial funding. KPLP made significant payments to the living trust over the remainder of their lives. The taxpayers claimed that the payments were for management fees. However, the Tax Court's rejection of the management-fee claim is supported by (1) the lack of a written management contract between the living trust and KPLP, (2) A's failure to keep track of the hours he spent managing KPLP, (3) the manner in which the payments were made and (4) A's failure to report the payments as self-employment income. In addition, A and E retained less than $10,000 in assets in the living trust (their only source of income) following the funding of KPLP--despite the fact both were in poor health and could expect to incur living expenses beyond amounts their Social Security benefits would cover.
Several circuits have reviewed decisions from the Tax Court with similar facts and concluded that the court did not dearly err in finding a retained right of control; see Est. of Albert Strangi, 417 F3d 68 (5th Cir. 2005); Est. of Ida Abraham, 408 F3d 26 (1st Cir. 2005); and Est. of Betsy T. Thompson, 3d Cir., 9/1/04. We agree with those decisions, and affirm the Tax Court's finding that A and E retained for their lives the right to the income from the assets transferred to KPLP.
Bona fide sale exception: We also find no dear error in the Tax Court's finding that the KPLP transfer did not satisfy the Sec. 2036(a) exception for bona fide sales for adequate consideration. Sec. 2036 contains an exception excluding from the gross estate transfers a decedent made prior to death if the transfer is "a bona fide sale for an adequate and full consideration in money or money's worth." A transfer is typically not deemed a bona fide sale when the taxpayer stands on both sides of the transaction; see Est. of Wayne C. Bongard, 124 TC 95 (2005); see Satchit, "Bongard: Tax Incorrectly Expands Sec. 2036(a)'s Application," TTA, August 2005, p. 476. The transaction must "be made in good faith" which requires an examination as to whether there was "some potential for benefit other than the potential estate tax advantages that might result from holding assets in the partnership form" (Thompson).
A formed KPLP with the help of his estate lawyer and without the involvement of his sons, who testified they were unfamiliar with the terms of the KPLP agreement. A alone decided which assets would be included in funding the partnership. As a consequence, the Tax Court found that A "essentially stood on all sides of the partnership's formation and approved the provisions of the KPLP agreement without negotiation or input from the limited partners." The Tax Court also rejected A and E's claim that KPLP was created to protect the family from commercial and personal injury liability arising from their bridge-building business, as well as liability from divorce, stating, "the estate has not shown that the terms of the KPLP agreement would prevent a creditor of a partner from obtaining that partner's KPLP interest in an involuntary transfer." The Tax Court found that A and E formed KPLP to make a testamentary transfer of their assets to their sons at a discounted value while still having access to the income from those assets for their lives. We find no basis for concluding that the Tax Court's factual determinations are clearly erroneous and, thus, affirm its decision.
EST. OF AUSTIN AND EDNA KORBY, 8TH CIR., 12/08/06
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|Title Annotation:||ESTATES, TRUSTS & GIFTS|
|Publication:||The Tax Adviser|
|Date:||Feb 1, 2007|
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