Taxpayer loses FLP appeal on retained rights.
After protracted litigation, the Tax Court found that S had retained an interest in the transferred assets such that they were properly included in his estate under Sec. 2036(a), and it sustained the IRS's deficiency; see Est. of Albert Strangi, TC Memo 2003-145. E appealed to the Fifth Circuit.
E advances two primary arguments on appeal, both of which hinge on Sec. 2036(a)'s application. First, it contends that the Tax Court erred in holding that S retained (1) "possession or enjoyment" of the property he transferred to SFLP or (2) the right to designate who would possess or enjoy it. If S did not retain such an interest, Sec. 2036(a) does not apply. Second, E contends that, even if S retained possession or enjoyment of the assets, the Tax Court erred in holding that the transfer did not fall within Sec. 2036(a)'s "bona fide" sale exception.
Possession and Enjoyment
The core of E's argument on appeal is that the Tax Court erred in concluding that S retained possession or enjoyment of the assets he transferred to SFLP. Sec. 2036(a) is one of several Code provisions intended to prevent parties from avoiding the estate tax by means of testamentary substitutes that permit a transferor to retain lifetime enjoyment of purportedly transferred property. Specifically, under Sec. 2036(a), property transferred by a decedent will be included in the taxable estate if, after the transfer, the decedent retains either (1) "possession or enjoyment" of the transferred property; or (2) "the right ... to designate the persons who shall possess or enjoy the property or the income therefrom."
Transferors retain "possession or enjoyment" of property, within the meaning of Sec. 2036(a)(1), if they retain a "substantial present economic benefit" from the property, as opposed to "a speculative contingent benefit which may or may not be realized" (Byrum, 408 US 125 (1972)). Regs. Sec. 2036-1(a) further requires that there be an "express or implied" agreement "at the time of the transfer" under which the transferor will retain possession or enjoyment of the property.
In the case at bar, the benefits retained by S--including, for example, periodic payments made prior to his death, continued use of the transferred house and post-death payment of various debts and expenses-were clearly "substantial" and "present," as opposed to "speculative" or "contingent." Thus, the inquiry under Sec. 2036(a)(1) turns solely on whether there was an express or implied agreement that S would retain de facto control and/or enjoyment of the transferred assets. The IRS does not suggest that any express agreement existed.
The Tax Court presented a litany of circumstantial evidence to support its conclusion that S had an implied agreement with his children. Part of the "possession or enjoyment" of one's assets is the assurance that they will be available to pay various debts and expenses at death. In this case, SFLP distributed over $100,000 from 1994-1996 to pay for funeral and estate administration expenses, specific bequests and various personal debts that S had incurred. These repeated distributions provide strong circumstantial evidence of an understanding between S and his children that SFLP assets would be used to meet S's expenses.
Second, S's continued occupancy of his home is evidence of an implied agreement. Third, S's lack of liquid assets after the transfer to SFLP is evidence that some arrangement to meet his expenses must have been made. S transferred over 98% of his wealth to SFLP and afterward, retained only $762 in truly liquid assets. Given these circumstances, the Fifth Circuit upholds the Tax Court's holding that S and his children had some implicit understanding by which S would continue to use his assets as needed and, thus, retain "possession or enjoyment" within the meaning of Sec. 2036(a)(1).
Bona Fide Sale Exception
Sec. 2036(a) provides an exception for any transfer of property that is a "bona fide sale for an adequate and full consideration in money or money's worth." The exception contains two discrete requirements: (1) a bona fide sale and (2) adequate and full consideration; see Est. of Morton B. Harper, TC Memo 2002-121. Both must be satisfied for the exception to apply. The adequate and full consideration prong of the exception is met; thus, the sole question becomes whether the transfer was a bona fide sale. "Bona fide" taken literally, means "in good faith" or "without fraud or deceit"; see Black's Law Dictionary (8th ed. 2004), p. 186.
Whether an asset transfer is a bona fide sale under Sec. 2036(a) is a purely objective inquiry; see David A. Kimbell, 371 F3d 257 (5th Cir. 2004). According to the Fifth Circuit, the finder of fact is charged with making an objective determination as to what, if any, nontax business purposes the transfer was reasonably likely to serve at its inception.
E proffered five discrete nontax rationales for S's transfer of assets to SFLP:
1. Deterring potential tort litigation by S's former housekeeper;
2. Deterring a potential will contest;
3.Persuading a corporate executor to decline to serve;
4. Creating a joint investment vehicle for the partners; and
5. Permitting centralized, active management of working interests owned by S.
The Tax Court rejected each of the rationales as factually implausible. The Fifth Circuit analyzed the factual bases for each of the arguments in depth and held that the Tax Court did not clearly err in finding that S's asset transfer to SFLP lacked a a substantial nontax purpose. Accordingly, the bona fide sale exception to Sec. 2036(a) was not met, and the transferred assets were includible in the taxable estate.
Rosalie Gulig, 5th Cir., 7/15/05
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|Title Annotation:||family limited partnership|
|Publication:||The Tax Adviser|
|Date:||Sep 1, 2005|
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