PLANNED GIVING & ENDOWMENTS
IN FAMILY PARTNERSHIPS AND LIMITED
MAY 27, 2010
Outline and Presentation by
Laurence Keiser, Esq., CPA
Stern Keiser & Panken, LLP
1025 Westchester Avenue
White Plains, NY 10604
Howell Bramson, Esq.
McCarthy Fingar LLP.
11 Martine Avenue
White Plains, New York 10606
1. Estate of Schauerhamer v. Commissioner, 73 TC Memo 1997-242 (1997). The value of property transferred by a decedent to three family limited partnerships (FLPs) was includible in the decedent's gross estate under the Code Sec. 2036(a) retained life estate rule where the Tax Court concluded that there was an implied agreement between the partners and the decedent that she would retain the full beneficial enjoyment from the assets. The decedent, who managed a closely held corporation and several rental properties, transferred some of her business assets to the FLPs approximately one year before her death. As managing partner of each FLP, the decedent had full power to manage and conduct the FLP's business operation, and she in fact did so until shortly before her death. The Tax Court said that the existence of an implied agreement was established by the following facts:
(a) The decedent, in violation of the partnership agreements, deposited the income from the FLPs into the account used by her as a personal checking account, where it was commingled with income from other sources. According to the Tax Court, deposits of income from transferred property into a personal account were highly indicative of “possession or enjoyment”.
(b) The decedent's children acknowledged that the formation of the FLPs was merely a way to enable the decedent to assign interests in the partnership assets to members of her family, and that the assets and income would be managed by the decedent exactly as they had been managed in the past. According to the Tax Court, where a decedent's relationship to transferred assets remains the same after the transfer as it was before the transfer, Code Sec. 2036(a)(1) requires that the assets be included in the estate.
2. Estate of Reichardt v. Commissioner, 114 T.C. 144 (2000). The Tax Court held that the property an individual transferred to a family partnership was includible in his gross estate under Code Section 2036(a) because he retained the enjoyment of the property during his lifetime. Reichardt continued to be the only person with the authority to sign partnership checks and documents and continued to live at his residence even after transferring it to the partnership and he commingled partnership and personal funds. The Tax Court found that the Reichardt and his children had an implied agreement that he could continue to possess and enjoy the assets, and retain the right to the income from the assets.
Fourteen months before his death, the decedent formed a revocable living trust and an FLP. The decedent appointed himself and his two children as co-trustees and authorized each trustee to act on behalf of the trust. The decedent was entitled to receive the net income of the trust at least annually, and he was entitled to use the trust corpus for his support, maintenance, health, and general welfare. The trust was the FLP's only general partner.
The decedent transferred all of his property (except for his car, personal effects, and a small amount of cash) to the FLP. One of the assets which the decedent transferred to the FLP was his residence. After the transfer, the decedent continued to live in the residence without paying rent. The decedent commingled partnership and personal funds by depositing some partnership income in his personal account and using the FLP's checking account as his personal account. Four months after creating the FLP, the decedent gave each of his children a 30.4% interest in the FLP. On the estate tax return filed for the decedent's estate, the executor reported that the gross estate included a 36.46% limited partnership interest in the FLP and a 1% general partnership interest in the FLP.
The Tax Court held that all of the property that the decedent transferred to the FLP was includible in his gross estate under Code Sec. 2036(a). The Tax Court found that the decedent did not curtail his enjoyment of the transferred property after he formed the FLP, but that the decedent's relationship to the transferred assets remained the same after he transferred them. Nothing changed except legal title.
3. TAM 9938005 (June 7, 1999). The IRS determined that the value of closely-held stock transferred by the decedent to a family limited partnership is includible in the decedent’s gross estate under Code Section 2036(b), because, in his capacity as general partner, the decedent retained the right to vote the stock. Two brothers each owned a 50% interest in a corporation. The corporation had a revolving credit agreement with a bank and under the agreement the brothers had to devise a plan of management and ownership. The brothers each transferred 55% of their stock to a family limited partnership. Each brother retained the right to vote the stock as general partners. One of the brothers transferred some of his partnership units to his four children and placed his remaining units in a revocable trust whereby the trust assets passed to his children on his death. When the brother died, the trust held his partnership units and 22.5% of the outstanding stock in the corporation. The Service determined that the decedent transferred his stock for less than adequate consideration because he did not receive all of the consideration for his transfer of stock to the partnership. In addition, the transfer to the partnership, which was designed to produce an estate freeze, could not be characterized as a bona fide sale. Since the decedent retained the right to vote the stock as a general partner, the Service concluded that the stock was includible in his gross estate.
4. Harper, Morton B. Est, (2002) TC Memo 2002-121 (May 14, 2002). The Tax Court said this case bore many similarities to Schauerhamer and Reichardt. The Court also held that assets which a decedent transferred to an FLP (from his revocable trust) were includible in the decedent's gross estate because there existed an implied agreement that the decedent would retain the economic benefit of the assets transferred to the FLP. The decedent was initially named as the sole limited partner and his two children were designated as general partners. The decedent later gave his children 24% and 36% limited partnership interests, respectively. At his death, the decedent continued to hold a 39% limited partnership interest in the FLP. In support of its conclusion that there was an implied agreement that the decedent would retain the economic benefit of all the FLP's assets, the court focused on (1) the commingling of funds, (2) the history of disproportionate distributions, and (3) the testamentary characteristics of the arrangement.
With respect to the commingling of funds, the Tax Court found that the disregard for the partnership form was egregious. The FLP began its legal existence on June 14, '94 (when a certificate of limited partnership was filed with the state Secretary of State), yet no bank account was opened for the FLP until Sept. 23, '94. Before that time, partnership income was deposited in the account of the decedent's revocable trust, resulting in an unavoidable commingling of funds. Similarly, no attempt was made to begin the process of title transfer until July 26, '94, when the decedent executed an endorsement assigning a promissory note to the FLP. No action was taken with respect to any of the other securities transferred to the FLP until Sept. 29 and 30, '94. Thus, at the time of the creation of the FLP and for some months afterwards, the decedent's revocable trust retained title to the assets and was issued the dividends and interest generated by those assets. The Tax Court said that this “[spoke] volumes” about how little the partners understood to have changed in the decedent's relationship to his assets as a result of the formation of the FLP.
With respect to the distribution of partnership funds, the court found equally compelling signs of an implied understanding or agreement that the partnership arrangement would not curtail the decedent's ability to enjoy the economic benefit of the assets contributed to the FLP. The distributions made by the decedent's son, as managing general partner, were heavily weighted in favor of the decedent: from Sept. '94 to Nov. '95, partnership funds of $5,800 and $8,700, respectively, were distributed for the benefit of the decedent's son and daughter, while checks totaling $231,820 were remitted to the decedent's revocable trust. Also significant was evidence that certain of the distributions to the decedent's revocable trust were linked to a contemporaneous personal expense of the decedent. The court said that this evidence buttressed the inference that the decedent had ready access to partnership cash when needed.
Finally, the Tax Court focused on the testamentary characteristics of the partnership arrangement, concluding that the FLP had minimal practical effect during the decedent's life and served primarily as an alternate vehicle through which the decedent would provide for his children after his death. The court said that this conclusion was supported by the subjective motivation underlying the creation of the FLP: six months before the FLP was created, an arbitration award had been entered against the decedent's daughter in connection with renovation work done on her condominium. The estate conceded that the decedent's primary reason for transferring assets to the FLP was to create an arrangement that would protect, from his daughter's creditors, the assets that she would inherit from the decedent. Thus, the impetus that prompted the decedent to create the FLP centered on what would happen to his property after his death. The court also noted that property contributed to the FLP constituted the majority of the decedent's assets (including nearly all of his investments), and said that this was not at odds with what one would expect to be the prime concern of an estate plan.
5. Estate of Strangi v. Commissioner, 115 TC 478 (2000), aff’d in part and rev’d and remanded in part, 293 F.3d 279 (5th Cir. 2002) (known as Strangi I) and Estate of Strangi v. Commissioner, T.C. Memo. 2003-145 (May 20, 2003) (known as Strangi II). Decedent’s son-in-law, an estate planning attorney who also held the decedent’s power of attorney, formed an FLP two months before decedent’s death. After formation, the son-in-law transferred about $2 million of decedent’s assets to the FLP in exchange for a 99% limited partnership interest. The general lpartner, which owned 1% of the partnership, was a corporation in which decedent owned a 47% interest. Decedent’s children owned the remainder of the corporation’s shares, but for a 1% share, which was owned by a charitable foundation. The partnership agreement gave the general partner the sole discretion to determine distributions. Decedent has used partnership assets to pay for personal expenses, including nursing care. At his death, decedent’s FLP interests comprised more than 96% of his estate. Decedent’s estate tax return included the 99% limited partnership interest, but with a 43.75% discount for lack of marketability and minority interest. The IRS determined a deficiency in estate and gift tax. Largely on the basis that the decedent’s interest in the FLP should have been increased for estate and gift tax purposes. The IRS claimed, in part, that Code Sec. 2036(a) ought to apply to assets the decedent had transferred to the FLP due to his retained interest in, and control of those assets.
The Tax Court in Strangi I held that the FLP was valid under state law because the entity complied with all necessary formalities, and because the partnership had sufficient substance to be recognized for tax purposes. However, the Tax Court did note that it was skeptical of the non-tax avoidance reasons for formation of the FLP. The Tax Court refused to consider the Code Sec. 2036(a) issue because the IRS had asserted the issue too close to the trial date. The Fifth Circuit upheld the majority of the Tax Court’s findings, but remanded on the 2036(a) issue.
On remand, in Strangi II, the Tax Court held that Code Sec. 2036(a) applied to assets transferred by decedent to the FLP because decedent implicitly retained economic benefit from the transferred property, including the right to receive the income therefrom. Crucial to the court’s decision were the following facts:
(1) Decedent died two months after the FLP was created;
(2) Decedent transferred substantially all of his assets to the FLP;
(3) Decedent’s attorney-in-fact controlled the FLP;
(4) FLP assets were used for decedent’s personal expenses; and
(5) No other partner had a meaningful economic interest in the FLP. Also concluded that assets were includible under 2036(a)(2) because decedent, through his attorney-in-fact, retained the right to determine who would benefit from the assets and the income generated therefrom.
Implied agreement existed among the partners of the FLP to allow the decedent to retain the use and enjoyment of, or the income from, the underlying assets.
6. Estate of Stone v. Commissioner, T.C. Memo 2003–309 (Nov. 7, 2003). Unique facts. The Stones transferred certain assets, including real estate and family holding company stock, to 5 FLPs only two months before Mr. Stone’s death in 1997. The process which led to the funding of the partnerships started in 1992 with the onset of litigation among the Stones’ children over the family’s assets. The children had become actively involved in managing the assets in 1995 by which time the parents had lost interest in such matters. Final settlement of the litigation coincided with the funding of the partnerships.
The Tax Court concluded that the transfers to the FLPs were made for adequate and full consideration. This is an exception to Section 2036(a)(1). Harper (see below) was distinguished, as were similar cases, by emphasizing the following facts:
Since these facts supported the Section 2036(a)(1) exception, the Court found it unnecessary to address the issue of whether the enjoyment of transferred assets that had been retained should be included in the decedent's gross estate.
7. Estate of Abraham, T.C. Memo 2004-39 (Feb. 18, 2004). Good example of what not to do. In 1993, Ida Abraham, the decedent, was placed under a guardianship; two daughters were appointed permanent guardians; and the two daughters petitioned the probate court for authority to make gifts from decedent’s funds not needed for her maintenance and support (reason given was that decedent’s estate “is likely to be subject at her death to . . . taxes at the highest marginal tax rates then in effect”). The probate court granted the request.
On June 13, 1994, decedent’s three children and decedent’s guardians agreed to a stipulation and agreement to establish an estate plan for decedent. Pursuant to the plan, three FLPs were formed; each FLP owned a real estate trust; three separate corporate GPs – president of each was decedent’s limited GAL who had the “exclusive right” to manage the FLPs; stock of GP was held in trust in which trustee was a GAL for decedent and had the power to pay, during decedent’s lifetime, the net income and principal of the trust to decedent for her benefit. Initially, decedent held a 98% limited partnership interest in 2 of the FLPS, the corporate GPs each held 1% and two daughters each held 1%. In the third FLP, decedent initially held 99%, and GP owned the other 1%. Each of decedent’s children had the right to purchase additional units from each of their respective FLPs, the proceeds from which were to be held in a revocable trust for the benefit of decedent during her life for her needs and then held for such child and his or her family. The FLPs were formed in October 1995.
A 15% minority interest and a 25% marketability discount were used to arrive at a value of $5,795 per 1% interest for each of the two FLPs in which the daughters were interested and $5,546 per 1% interest in the FLP in which the son was interested. Amounts were paid by the two daughters to the decedent and to the FLPs to purchase limited partnership interests; the amounts paid were based on the discounted values. Gifts were made, also based on the discounted values. Decedent’s remaining interests in the FLPs were valued, for estate tax purposes, using a 30% to 40% discount. IRS maintained that 70% of the value of the assets in one FLP (son owned the other 30%) and 100% of the value of the other FLPs were includible in decedent’s gross estate.
IRS contended that implied agreement existed amongst the children and limited GAL that decedent would retain the right to the income generated by the FLP interests transferred and that Section 2036 therefore resulted in full value of FLP interest being includible in the gross estate.
Tax Court noted that decedent continued to enjoy the right to support and maintenance
from all of the income that the FLPs generated; decedent’s support needs were treated as an obligation of the FLPs; in the decree, the children agreed that they would share equally any and all costs and expenses related to the support of their mother “insofar as the funds generated by her properties maintained by her do not provide sufficient funds for her adequate health, safety, welfare and comfort” and that her living arrangement shall remain in accordance with the present arrangement and every effort will be made to maintain her in “status quo.” The testimony at trial restated these intentions.
It was clear to the Court that, at the time of the transfers, decedent explicitly retained the right to the income that the FLPs generated to the extent necessary to meet her needs.
With respect to the 2036 exception re a transfer in good faith, at a price of adequate and full value, the Court noted that there was no evidence as to the fair market value of the FLP interests on the date the daughters purchased them; no evidence that the discounts claimed were appropriate (an appraiser’s letter stated that he made “no representation * * * that these discounts will hold up” and there was no expert witness reports in the record). Accordingly, there was no proof that the daughters’ payments constituted adequate and full consideration.
8. Estate of Lea K. Hillgren v. Commissioner, T.C. Memo 2004-46 (Mar. 3, 2004). Tax Court concluded that value of properties transferred to limited partnership was includible under §2036(a). Decedent was treated for mental illness beginning in 1984. Around October 1996, decedent ended her relationship with a boyfriend. On October 31, 1996, decedent attempted to commit suicide by overdose of medications, alcohol and carbon monoxide poisoning. On March 21, 1997, she was admitted to a hospital for pain in her arm and neck; she was taking five different medications, and suffered degenerative disc disease of the cervical spine. On June 5, 1997, at the age of 41, decedent committed suicide.
The Lea K. Hillgren Partnership (“LKHP”) was formed on January 1, 1997. Decedent held a 99.95% capital interest and a 75% profit interest; her brother received a .05% capital interest and a 25% profit interest in the partnership, allegedly for services rendered in forming the partnership. Decedent made no other gifts or transfers of partnership interests.
Decedent contributed seven properties to LKHP, but no deed or transfer of title to the seven properties was ever made to the partnership. The partnership agreement provided that title to any property contributed and was deemed to be owned by the partnership, would remain in the name of the limited partner for the benefit of the partnership. Leases that encumbered the properties were not formally assigned to LKHP prior to decedent’s death. Title remained in the name of decedent or another entity owned by her (Sea Shell) in order to hide the change of ownership from the general public and from the tenants of the properties. On May 27, 1997, decedent executed seven quitclaim deeds, transferring her interest in the LKHP properties to an amended trust. The deeds were unrecorded at the time of her death.
The partnership agreement further provided that the general partner need not open a bank account in the name of the partnership, but could instead maintain the existing bank account that was used by Sea Shell and the amended trust. After the formation of LKHP, leases were executed on the LKHP properties in the name of Sea Shell; all contracts for maintenance and improvement of the LKHP properties were in the name other than that of LKHP; a check was issued under the name of Sea Shell to pay property taxes for various properties including two that were owned by LKHP; and Sea Shell paid for landlord’s insurance on one of LKHP’s properties. During a loan application process, it was represented to a mortgage broker and a lender that decedent owned and controlled all of the LKHP properties.
From January 1 through June 5, 1997, decedent received distributions totaling $99,363; her brother did not receive any distributions. The distributions received by decedent enabled her to pay her living expenses; she was dependent on the cash flow of the partnership to cover her personal expenses.
The Court noted that where a decedent conveys all or nearly all of his or her assets to a trust or partnership, this may suggest an implied agreement that the decedent can continue to use the assets. Decedent’s transfer of all her properties and her dependence on the distributions from the partnership, along with the commingling of funds, the egregious disregard of the partnership form, and the post-mortem accounting manipulations that had occurred, led the Tax Court to easily conclude that all of the properties were includible under §2036(a). Of course, the Tax Court may have come to the same result even without §2036(a) since, as the Tax Court noted, neither decedent’s interest in the properties that were transferred to the partnership nor legal title changed once the partnership was established. The Tax Court rejected the Estate’s claim that the partnership agreement changed any real relationship between decedent and her brother or that it changed decedent’s interest in the properties.
The decedent had been the sole shareholder of an operating company until 1986, when he contributed 15% of his stock to a trust he created for his children and his stepdaughter. In January 1996, decedent created an LLC, and in December 1996, he and the trust contributed all of their stock in the operating company to the LLC in exchange for four classes of interests in the LLC, one voting and three nonvoting. At the same time, the decedent created an FLP and transferred his Class B nonvoting units in the newly formed LLC to the FLP and the trust contributed a portion of it Class B nonvoting units to the FLP. The decedent died unexpectedly two years later at age 58.
The court concluded that the formation of the LLC was covered by the bona fide sale exception to 2036(a)(1), largely because business advisors recommended the LLC holding company as a way to attract outside investors for the company. The court held that the formation of the FLP did not satisfy the “bona fide sale for full consideration” exception and held that 2036(a)(1) applied to the formation of the FLP, so the decedent had to include the underlying assets of the FLP (i.e. the Class B LLC units that had been transferred to the FLP) in the estate, rather than discounted limited partnership interests.
Importantly, the case does not impact the use of FLPs as part of a gift or sale program. In fact, the court hints that using an FLP as part of a program of making gifts may constitute a legitimate nontax reason for using an FLP for purposes of applying the bona fide sale for full consideration threshold to 2036.
The court announced a new standard for determining whether the bona fide sale threshold is satisfied. The new standard is summarized by the court as follows: “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.”
Although the case held against taxpayer, the use of the LLC resulted in about $42.6 million of discounts.
Consider sale or gift of limited partnership interests at discounted value. As long as 2035 does not apply, the sale or gift would avoid the inclusion of the underlying assets of the FLP in the gross estate without a discount.
The court discussed the issue of “practical control” as a way to bring back assets under 2036(a)(1). Query how this may affect different types of irrevocable trusts.
In December 1994, decedent’s revocable trust contributed investment property to an FLP (but not the $450,000 of liabilities secured by the property, which remained as liabilities of the revocable trust). The trust was the sole general partner (1%). The trust received most of the limited partnership units. (The children each contributed $100 for a very small limited partnership interest). The FLP made payments on the loan (owed by the revocable trust) and paid some of the decedent’s living expenses. The son (as agent) made 40 transfers between the FLP and the revocable trust during a period of a little over two years.
In December of the years 1994 through 1997, the son (as agent under the power of attorney) withdrew some of the trust’s units in the FLP and made gifts to himself and his sisters and to the decedent’s grandchildren.
Decedent died in August1997 (when the revocable trust owned the 1% general partnership interest and a 45% limited partnership interest), and the FLP was terminated a little over one year later.
The estate claimed a 31% marketability discount on the gifts of the FLP interests and claimed a 37% marketability discount on the value of the limited partnership interests for estate tax purposes.
The court held that 2036(a)(1) applies because there was an implied agreement for decedent to retain income from and enjoyment of the rental property that was contributed to the FLP and the bona fide sale exception to 2036 does not apply.
This was a bad factual case for the taxpayer because of substantial disproportionate distributions to the decedent, the inability of decedent to meet her living expenses without distributions, and the use of partnership property to secure the decedent’s liabilities. The court found that there were no nontax factors to explain the formation of the FLP. The court here (unlike the full court in Bongard) stated that a transfer to an FLP for the purpose of facilitating gift giving cannot be a bona fide transfer for purposes of the bona fide sale for full consideration exception to 2036.
The court included the gifted interests in the taxable estate, but did not explain why. The gifts were made within three years of death, so it is possible that Section 2035 would have applied.
B. Interests Gifts of Partnership Recharacterized as Gifts of Underlying Property.
Estate of Senda v. Commissioner, 433 F.3rd 1044 (8th Cir. January 6, 2006), is one of very few gift tax cases involving FLPs.
The donors (a husband and wife) created two FLPs (FLP I and FLP II). The donors signed the FLP I agreement on Apr. 1, '98. The partnership agreement provided that a .01% limited partnership interest was initially held in trust for each of the donors' three minor children. On Dec. 28, '98, the donors contributed 28,500 shares of MCI WorldCom stock to FLP I by transferring the stock from their joint brokerage account to the brokerage account of FLP I. By fax dated Dec. 28, '98, the donors informed their accountant that they had transferred stock to FLP I, and sought advice as to what percentage of partnership interests they should transfer to the children. On that same day, the husband gave each child (or trust for that child) a 29.94657% limited partnership interest in FLP I and the wife gave each child (or trust for that child) a 0.0434% limited partnership interest in FLP I. The certificates of ownership reflecting the transfers were not prepared and signed until several years later.
The donors signed the FLP II agreement on Dec. 17, '99. As with FLP I, the partnership agreement provided that a .01% limited partnership interest was initially held in trust for each of the donors' three minor children. On Dec. 20, '99, the donors contributed 18,477 shares of MCI WorldCom stock to FLP II by transferring the stock from their joint brokerage account to the brokerage account of FLP II. On that same day, the donors gave to each child, in trust, a 17.9% limited partnership interest in FLP II. By fax dated Dec. 22, '99, the donors informed their accountant that they had transferred stock to FLP II, and sought advice as to the percentage of partnership interests they should transfer to the children to maximize their annual gift tax exclusions and use all of their remaining unified credits. On Jan. 31, 2000, the donors gave to each child, in trust, an additional 4.5% limited partnership interest in FLP II.
On their '98, '99, and 2000 gift tax returns, the donors reported the transfers as gifts of partnership interests to their children. The values of the partnership interests were determined by multiplying the value of the transferred stock (as to which there was no dispute) by the percentage of the partnership interests transferred to the children, and then applying lack of marketability and minority interest discounts.
IRS conceded that the Jan. 31, 2000 gifts were gifts of partnership interests, not gifts of stock. But IRS argued that the Dec. 28, '98 transfer of stock to FLP I, and the Dec. 20, '99 transfer of stock to FLP II, coupled with the transfer of limited partnership interests to the donors' children, were indirect gifts of the stock to the children. Thus, IRS argued that the stock, not the partnership interests, had to be valued for gift tax purposes. According to IRS, “the transitory allocations to [the donors'] capital accounts, if such allocations even occurred at all, were merely steps in integrated transactions intended to pass the stock to the [donors'] children in partnership form.”
The Tax Court—which was affirmed by the Eighth Circuit—agreed with IRS, saying that the donors had presented no reliable evidence that they contributed the stock to the FLPs before they transferred the partnership interests to their children. At best, the transactions were integrated and, in effect, simultaneous. The Tax Court found that the donors were “more concerned with ensuring that the beneficial ownership of the stock was transferred to the children in tax-advantaged form than they were with the formalities of FLPs,” and noted that the husband, as general partner, did not maintain any books or records for the partnerships other than brokerage account statements and partnership tax returns. The tax returns were prepared months after the transfers of the partnership interests, and thus were unreliable in showing whether the donors transferred the partnership interests to the children before or after they contributed the stock to the partnerships. The same was true of the certificates of ownership reflecting the transfers of the partnership interests, which were not prepared until at least several weeks after the transfers. And the letters that the donors faxed to their accountant after they had funded the partnerships did not establish—as the donors contended—that the donors first funded the partnerships and then transferred the partnership interests to their children. The faxes established only that the donors had funded the partnerships; they did not show what the partnership ownership interests were immediately before the funding, or how the stock was allocated among the partners' capital accounts at the time of the funding. The Tax Court concluded that the value of the children's partnership interests was enhanced upon the donors' contributions of stock to the FLPs. Thus, the transfers were indirect gifts of stock to the children.
The Eighth Circuit discussed the step transaction doctrine. In light of this case, it is especially important to have partnership contributions precede in time, by as long as possible, the subsequent gifts or sales of partnership interests.
C. Gifts are not “Present Interests.”
1. TAM 9944003 (July 2, 1999). The Service ruled that gifts of limited partnership interests constitute gifts of present interests that will qualify for the annual exclusion under code Section 2503(b). Under the terms of the Partnership Agreement in the case, the general partners are solely responsible for the management of the partnership business and the timing and amount of any distributions are within the sole discretion of the general partnership. The agreement gives the limited partner the right to assign his or her partnership interest. The National Office ruled that the gifts of limited partnership interests to the children of the general partner constitute an outright gift of ownership interest in the partnership and each donee received the immediate use, possession and enjoyment of the interest, including the right to sell or assign the interest, which thus constitute present interests that qualify for the annual gift tax exclusion.
2. Hackl v. Commissioner, 118 T.C. 14 (March 27, 2002). The Tax Court ruled that the gift of LLC membership units by a husband and wife to their children and grandchildren failed to qualify for the annual gift tax exclusion because the donees did not have the immediate use, possession, or enjoyment of the LLC units. The opinion concludes that the LLCs operating agreement prevented the donees from obtaining any immediate substantial economic benefit from the LLC units because the donees could not (1) unilaterally withdraw their capital account, (2) sell their units without the approval of the LLC’s manager, or (3) effectuate a dissolution of the LLC by themselves. The Court also accepted the contention that the donees did not have the immediate use, possession, or enjoyment of the income from the LLC units because the LLC not expected to produce immediate income, and any income generated would only be distributed at the manager’s discretion. The Court rejected the Hackls’ argument that when a gift takes the form of an outright transfer of an equity interest in property, no further analysis is needed or justified.
IV. General Valuation Issues
A. Peracchio v. Commissioner, T. C. Memo 2003–280 (Sept. 25, 2003). An FLP owned cash and money market funds (44%) and marketable securities (56%). Mr. Peracchio either gave or sold most of the limited partnership interests to a trust. His 1997 gift tax return showed a combined 40% discount. The Tax Court determined a 6% discount for minority interest and 25% for lack of marketability, resulting in a combined discount of 29.5%. The IRS had been just below 19%. It has been suggested that if the partnership had had plans to invest some or all of its large cash position, placing cash in another asset category might have increased the minority interest discount.
B. Estate of Dailey v. Commissioner, TC Memo 2001-263. The Tax Court accepted an estate's expert's opinion that an aggregate marketability and minority discount of 40% was warranted in valuing interests in an FLP under the following circumstances. In Oct. '92, the decedent created an FLP to which she contributed marketable securities. Upon execution of the agreement, the decedent took a 1% general partnership interest and a 98% limited partnership interest, and her son received a 1% limited partnership interest. In Dec. '92, when the assets held by the FLP had a fair market value of $1.2 million, the decedent gave a 45% limited partnership interest in the FLP to her son, a 15% limited partnership interest to her daughter-in-law, and a 38% limited partnership interest to a revocable living trust she had created. When the decedent died in Jan. '97, the assets held by the FLP had a market value of slightly over $1 million. The FLP also had substantial unrealized capital gains due to the increase in value of some of the stock that the decedent had contributed.
IRS and the estate agreed that (1) for gift tax purposes, the interests in the FLP which the decedent had given to her son and daughter-in-law were worth their proportionate share of the Dec. '92 net asset value of $1.2 million, and (2) for estate tax purposes, the interest in the FLP retained by the decedent was worth its proportionate share of the Jan. '97 net asset value of $1 million. They disagreed, however, about the size of the minority and marketability discounts. The estate's expert, citing published data, opined that the aggregate discount was 40% for lack of marketability, control, and liquidity. The estate's expert testified that he considered the significant amount of unrealized capital gains relating to the appreciated stock held by the FLP. IRS's expert, who relied in part on an unpublished study that he co-authored, opined that an aggregate discount of 15.72% (for gift tax purposes) and 13.51% (for estate tax purposes) should be applied. IRS's expert testified that he could not recall reviewing the limited partnership agreement, and he did not review the documents to determine if the FLP had any unrealized capital gains. The Tax Court said that IRS's expert's testimony was contradictory, unsupported by the data, and inapplicable to the facts. The court found that the estate's expert provided a more convincing and thorough analysis than IRS's expert. Thus, the Tax Court accepted the estate's expert's conclusion that an aggregate marketability and minority discount of 40% was applicable in valuing the FLP interests for gift and estate tax purposes.
C. Estate of Kelley v. Commissioner, TC Memo. 2005-235 (Oct. 11, 2005).
The Tax Court rejected the appraisals proffered by both the taxpayer and the IRS, but still awarded a 35% combined discount for lack of control and lack of marketability for interests in a family limited partnership that held only cash and certificates of deposit. The court rejected the estate's appraisal, because it considered only the bottom quartile of all closed-end mutual funds and instead chose to use the arithmetic mean of all the closed-end funds, because shareholders in all closed-end funds lack control. The court allowed a 12% discount for lack of control. The court also rejected the 38% lack-of-marketability discount claimed at trial by the estate, which was based on restricted stock studies, and the 15% discount claimed by the IRS, based on the Bajaj study of private placement of unregistered shares. The court allowed a 23% discount for lack of marketability, producing a total discount of 35%.