SCOTUS Reports

Tag: Family Limited Partnership

  • Estate of Turner v. Commissioner, T.C. Memo. 2011-209 (Supplemental Opinion): Application of Section 2036 and Marital Deduction in Estate Tax Calculations

    Estate of Turner v. Commissioner, T. C. Memo. 2011-209 (Supplemental Opinion), United States Tax Court, 2011

    In a significant ruling on estate tax law, the U. S. Tax Court reaffirmed its earlier decision that Clyde W. Turner Sr. ‘s transfer of assets to a family limited partnership was subject to Section 2036, thus including those assets in his gross estate. The court also addressed a novel issue regarding the marital deduction, concluding that the estate could not increase its marital deduction based on assets transferred as gifts before Turner’s death. This decision clarifies the application of Section 2036 and the limits of marital deductions, impacting estate planning strategies involving family limited partnerships.

    Parties

    The plaintiff in this case is the Estate of Clyde W. Turner, Sr. , with W. Barclay Rushton as the executor, represented by the estate’s legal counsel. The defendant is the Commissioner of Internal Revenue, representing the interests of the U. S. government in tax matters.

    Facts

    Clyde W. Turner, Sr. , a resident of Georgia, died testate on February 4, 2004. Prior to his death, on April 15, 2002, Turner and his wife, Jewell H. Turner, established Turner & Co. , a Georgia limited liability partnership, contributing assets valued at $8,667,342 in total. Each received a 0. 5% general partnership interest and a 49. 5% limited partnership interest. By January 1, 2003, Turner transferred 21. 7446% of his limited partnership interest as gifts to family members. At the time of his death, he owned a 0. 5% general partnership interest and a 27. 7554% limited partnership interest. The estate reported a net asset value for Turner & Co. of $9,580,520 at the time of Turner’s death, applying discounts for lack of marketability and control to value the partnership interests.

    Procedural History

    The initial case, Estate of Turner v. Commissioner (Estate of Turner I), resulted in a Tax Court memorandum opinion (T. C. Memo. 2011-209) holding that Turner’s transfer of assets to Turner & Co. was subject to Section 2036, thus including the value of those assets in his gross estate. The estate filed a timely motion for reconsideration under Rule 161, seeking reconsideration of the application of Section 2036 and the court’s failure to address the estate’s alternative position on the marital deduction. The Commissioner filed an objection to the estate’s motion. This supplemental opinion addresses these issues.

    Issue(s)

    Whether the Tax Court should reconsider its findings regarding the application of Section 2036 to the transfer of assets to Turner & Co. ? Whether the estate can increase its marital deduction to include the value of assets transferred as gifts before Turner’s death, in light of the application of Section 2036?

    Rule(s) of Law

    Section 2036 of the Internal Revenue Code includes in a decedent’s gross estate the value of property transferred by the decedent during life if the decedent retained the possession or enjoyment of, or the right to the income from, the property. Section 2056(a) allows a marital deduction for the value of any interest in property which passes or has passed from the decedent to his surviving spouse, provided that such interest is included in the decedent’s gross estate. The regulations under Section 2056(c) define an interest in property as passing from the decedent to any person in specified circumstances, but such interest must pass to the surviving spouse as a beneficial owner to qualify for the marital deduction.

    Holding

    The Tax Court denied the estate’s motion for reconsideration regarding the application of Section 2036, affirming its previous holding that the assets transferred to Turner & Co. are included in Turner’s gross estate. The court also held that the estate cannot increase its marital deduction to include the value of assets transferred as gifts before Turner’s death because those assets did not pass to the surviving spouse as a beneficial owner.

    Reasoning

    The court’s reasoning on Section 2036 reaffirmed the lack of significant nontax reasons for forming Turner & Co. , noting that the partnership’s purpose was primarily testamentary and that Turner retained an interest in the transferred assets. The court dismissed the estate’s arguments for reconsideration, finding no substantial errors or unusual circumstances justifying a change in the previous decision.

    Regarding the marital deduction, the court reasoned that the assets transferred as gifts before Turner’s death did not pass to Jewell as a beneficial owner, thus not qualifying for the marital deduction under Section 2056(a) and the applicable regulations. The court emphasized the policy behind the marital deduction, which is to defer taxation until the property leaves the marital unit, not to allow assets to escape taxation entirely. The court found no legal basis for the estate’s argument that the marital deduction could be increased based on assets included in the gross estate under Section 2036 but not passing to the surviving spouse.

    The court also considered the structure of the estate and gift tax regimes, noting that allowing a marital deduction for the transferred assets would frustrate the purpose of the marital deduction by allowing assets to leave the marital unit without being taxed. The court rejected the estate’s reliance on the formula in Turner’s will, as the assets in question were not available to fund the marital bequest.

    Disposition

    The Tax Court denied the estate’s motion for reconsideration regarding Section 2036 and held that the estate could not increase its marital deduction to include the value of assets transferred as gifts before Turner’s death. An appropriate order was issued consistent with the supplemental opinion.

    Significance/Impact

    This supplemental opinion clarifies the application of Section 2036 in the context of family limited partnerships and the limits of the marital deduction when assets are transferred as gifts before the decedent’s death. It reinforces the principle that assets included in the gross estate under Section 2036 do not automatically qualify for the marital deduction if they do not pass to the surviving spouse as a beneficial owner. The decision has significant implications for estate planning involving family limited partnerships, particularly in structuring transfers to minimize estate tax while maximizing the marital deduction. It also underscores the importance of considering the tax implications of lifetime gifts in the context of estate tax planning.

  • Estate of Turner v. Comm’r, 138 T.C. 306 (2012): Marital Deduction and Inclusion of Gifted Assets Under Section 2036

    138 T.C. 306 (2012)

    When assets are included in a decedent’s gross estate under Section 2036 due to a retained interest in a family limited partnership, the estate cannot claim a marital deduction for assets underlying partnership interests previously gifted to individuals other than the surviving spouse.

    Summary

    The Estate of Clyde W. Turner, Sr. petitioned for reconsideration of a prior ruling that included assets transferred to a family limited partnership (FLP) in the gross estate under Section 2036. The estate argued that even if Section 2036 applied, a marital deduction should offset any estate tax deficiency due to a clause in Clyde Sr.’s will. The Tax Court held that the estate could not claim a marital deduction for assets underlying partnership interests gifted before death, as these assets did not pass to the surviving spouse as a beneficial owner. This decision reinforces the principle that the marital deduction is intended to defer, not eliminate, estate tax and that gifted assets are not eligible for the marital deduction.

    Facts

    Clyde Sr. and his wife, Jewell, formed Turner & Co., a family limited partnership (FLP), contributing significant assets in exchange for partnership interests. Clyde Sr. gifted a portion of his limited partnership interest to family members during his lifetime. Upon his death, the IRS included the assets he transferred to the FLP in his gross estate under Section 2036, arguing that he retained an interest in those assets. The estate argued for an increased marital deduction to offset the increased estate value.

    Procedural History

    The Tax Court initially ruled that Section 2036 applied to include the FLP assets in Clyde Sr.’s gross estate (Estate of Turner I, T.C. Memo. 2011-209). The estate then filed a motion for reconsideration, arguing that the marital deduction should offset the increased estate tax. The Tax Court denied the motion, issuing a supplemental opinion clarifying the marital deduction issue.

    Issue(s)

    Whether the estate can claim a marital deduction for assets included in the gross estate under Section 2036 that underlie partnership interests previously gifted to individuals other than the surviving spouse.

    Holding

    No, because the gifted assets and partnership interests did not pass to the surviving spouse as a beneficial owner and therefore do not qualify for the marital deduction under Section 2056.

    Court’s Reasoning

    The court reasoned that Section 2056(a) allows a marital deduction only for property “which passes or has passed from the decedent to his surviving spouse.” The court emphasized that under Treasury Regulations Section 20.2056(c)-2(a), “a property interest is considered as passing to the surviving spouse only if it passes to the spouse as beneficial owner.” Since Clyde Sr. had already gifted the partnership interests (and the underlying assets) to other family members, those assets could not pass to Jewell as a beneficial owner. The court further explained that allowing a marital deduction for these assets would violate the fundamental principle that marital assets should be included in the surviving spouse’s estate (or be subject to gift tax if transferred during life). The court noted the consistency of this approach with the QTIP rules under Sections 2056(b)(7), 2044, and 2519, which ensure that assets for which a marital deduction is taken are ultimately subject to transfer tax. The court stated, “Although the formula of Clyde Sr.’s will directs what assets should pass to the surviving spouse, the assets attributable to the transferred partnership interest or the partnership interest itself are not available to fund the marital bequest…Because the property in question did not pass to Jewell as beneficial owner, we reject the estate’s position and hold that the estate may not rely on the formula of Clyde Sr.’s will to increase the marital deduction.”

    Practical Implications

    This case clarifies the interaction between Section 2036 and the marital deduction, particularly in the context of family limited partnerships. It serves as a warning to estate planners that including assets in the gross estate under Section 2036 does not automatically entitle the estate to a corresponding increase in the marital deduction. Specifically, assets underlying partnership interests gifted before death cannot be used to increase the marital deduction. This decision reinforces the IRS’s position that the marital deduction is limited to assets actually passing to the surviving spouse as a beneficial owner and prevents the avoidance of estate tax on gifted assets. It highlights the importance of carefully considering the implications of family limited partnerships and retained interests when planning for estate tax purposes. This case has been cited in subsequent cases involving similar issues, reinforcing its precedential value.

  • Estate of Black v. Comm’r, 133 T.C. 340 (2009): Family Limited Partnerships and Estate Tax Inclusion Under Section 2036

    Estate of Samuel P. Black, Jr. , Deceased, Samuel P. Black, III, Executor, et al. v. Commissioner of Internal Revenue, 133 T. C. 340 (U. S. Tax Court 2009)

    In Estate of Black, the U. S. Tax Court ruled that the transfer of Erie stock to a family limited partnership (FLP) did not result in estate tax inclusion under Section 2036, as it was a bona fide sale for adequate consideration. The court found that the FLP was formed with legitimate nontax motives, primarily to consolidate and protect family assets, upholding the use of FLPs for estate planning without triggering estate tax inclusion.

    Parties

    The petitioner was the Estate of Samuel P. Black, Jr. , deceased, with Samuel P. Black, III serving as the executor. The respondent was the Commissioner of Internal Revenue. The case involved consolidated proceedings from the U. S. Tax Court, docket Nos. 23188-05, 23191-05, and 23516-06.

    Facts

    Samuel P. Black, Jr. (Mr. Black), a key figure at Erie Indemnity Co. , contributed his Erie stock to Black Interests Limited Partnership (BLP) in 1993. This move was influenced by Mr. Black’s advisers, who recommended the FLP to consolidate the family’s Erie stock and minimize estate taxes. Mr. Black, his son Samuel P. Black, III, and trusts for his grandsons received partnership interests proportional to their contributed stock. The primary purpose was to implement Mr. Black’s buy-and-hold philosophy and protect the family’s stock from potential sale or pledge due to personal or familial financial pressures. Mr. Black passed away in December 2001, and his wife, Irene M. Black, shortly thereafter in May 2002.

    Procedural History

    The Commissioner issued notices of deficiency to Samuel P. Black, III, as executor of both Mr. and Mrs. Black’s estates, asserting estate and gift tax deficiencies. The petitioner contested these deficiencies, leading to a trial before the U. S. Tax Court. The court’s decision focused on whether the Erie stock transferred to BLP should be included in Mr. Black’s estate under Section 2036, among other issues.

    Issue(s)

    Whether the transfer of Erie stock to BLP by Mr. Black constituted a bona fide sale for an adequate and full consideration under Section 2036(a), thereby excluding the stock’s value from his gross estate?

    Rule(s) of Law

    Section 2036(a) of the Internal Revenue Code provides that the value of a gross estate includes the value of all property transferred by the decedent, except in the case of a bona fide sale for an adequate and full consideration in money or money’s worth. The court has established that for a transfer to a family limited partnership to qualify as such, it must have a legitimate and significant nontax purpose.

    Holding

    The Tax Court held that Mr. Black’s transfer of Erie stock to BLP constituted a bona fide sale for adequate and full consideration, and thus, the value of the transferred stock was not includable in his gross estate under Section 2036(a).

    Reasoning

    The court reasoned that Mr. Black’s transfer to BLP was motivated by significant nontax reasons, including the desire to consolidate and protect the family’s Erie stock from potential sale or pledge due to financial pressures on his son and grandsons. The court found that the partnership interests received were proportionate to the value of the contributed assets, satisfying the requirement for adequate and full consideration. The court also considered precedents such as Estate of Schutt v. Commissioner and Estate of Bongard v. Commissioner, which supported the finding that a legitimate nontax purpose for forming an FLP could be the perpetuation of a family’s investment philosophy. The court emphasized that Mr. Black’s concerns were based on actual circumstances rather than theoretical justifications, further supporting the bona fide nature of the sale.

    Disposition

    The court’s decision affirmed that the value of Mr. Black’s partnership interest in BLP, rather than the value of the Erie stock contributed to BLP, was includable in his gross estate.

    Significance/Impact

    Estate of Black is significant for its clarification of the requirements for a bona fide sale to an FLP under Section 2036. The decision supports the use of FLPs as a legitimate estate planning tool when formed with significant nontax motives, providing guidance on the factors courts consider when evaluating such transfers. The ruling has been influential in subsequent cases dealing with estate tax inclusion and the use of FLPs, affirming that estate planning strategies can be upheld when they serve legitimate family and business interests.

  • Holman v. Comm’r, 130 T.C. 170 (2008): Indirect Gifts and Valuation Discounts in Family Limited Partnerships

    Thomas H. Holman, Jr. and Kim D. L. Holman v. Commissioner of Internal Revenue, 130 T. C. 170 (U. S. Tax Court 2008)

    In Holman v. Comm’r, the U. S. Tax Court ruled that transfers of Dell stock to a family limited partnership (FLP) followed by gifts of partnership units were not indirect gifts of the stock itself. The court also addressed valuation discounts, rejecting the IRS’s argument to disregard certain transfer restrictions in the partnership agreement, and determined specific discounts for minority interest and lack of marketability in valuing the gifts, impacting how FLPs are used for estate planning and tax purposes.

    Parties

    Thomas H. Holman, Jr. and Kim D. L. Holman (petitioners) were the taxpayers who challenged the IRS’s gift tax assessments. They were residents of St. Paul, Minnesota, at the time of filing their petition. The Commissioner of Internal Revenue (respondent) was the opposing party in the case, represented by the IRS.

    Facts

    Thomas H. Holman, Jr. and Kim D. L. Holman, a married couple, formed a family limited partnership (Holman Limited Partnership) on November 3, 1999. They transferred 70,000 shares of Dell stock to the partnership, while Janelle S. Holman, as trustee of a trust set up for their children, contributed 100 shares. In exchange, the Holmans and the trust received partnership interests proportional to their contributions. On November 8, 1999, the Holmans made a gift of limited partnership units (LP units) to Janelle as custodian for their youngest child, I. , and as trustee for their children. Subsequent gifts of LP units were made in January 2000 and February 2001. The Holmans applied significant valuation discounts to these gifts, which the IRS contested, leading to a dispute over the appropriate valuation and tax treatment of the gifts.

    Procedural History

    The IRS issued notices of deficiency to the Holmans, determining gift tax deficiencies for the years 1999, 2000, and 2001. The Holmans filed a petition with the U. S. Tax Court challenging these determinations. The IRS amended its answer, increasing the deficiencies. The Tax Court heard the case, considering the IRS’s arguments regarding the characterization of the transfers as indirect gifts and the application of valuation discounts. The court’s decision addressed the IRS’s contentions and determined the fair market value of the gifts, applying appropriate discounts.

    Issue(s)

    Whether the transfer of Dell stock to the Holman Limited Partnership and the subsequent gifts of limited partnership units constituted indirect gifts of the Dell stock under Section 2511 of the Internal Revenue Code?

    Whether the restrictions on the transfer of limited partnership units in the partnership agreement should be disregarded under Section 2703 of the Internal Revenue Code in valuing the gifts?

    What are the appropriate discounts for minority interest and lack of marketability to be applied in determining the fair market value of the gifts of limited partnership units?

    Rule(s) of Law

    Section 2511 of the Internal Revenue Code imposes a gift tax on the transfer of property by gift, applying to both direct and indirect transfers. 26 C. F. R. sec. 25. 2511-2(a), Gift Tax Regs. , states that the value of a gift is determined by the value of the property passing from the donor, not by the enrichment to the donee. 26 C. F. R. sec. 25. 2703-1(b)(1)(iii), Gift Tax Regs. , provides that restrictions on the right to sell or use property are disregarded in valuation unless they meet certain criteria, including being a bona fide business arrangement, not a device to transfer property to family members for less than full consideration, and having terms comparable to arm’s-length transactions.

    Holding

    The Tax Court held that the transfer of Dell stock to the partnership followed by the gifts of LP units did not constitute indirect gifts of the Dell stock. The court also held that the restrictions on the transfer of LP units in the partnership agreement should be disregarded under Section 2703 of the Internal Revenue Code because they did not meet the criteria of a bona fide business arrangement and were a device to transfer property to family members for less than full consideration. The court determined the fair market values of the gifts after applying discounts for minority interest and lack of marketability.

    Reasoning

    The court reasoned that the Holman Limited Partnership was formed and funded almost one week before the first gift of LP units, and thus, the transactions could not be viewed as an indirect gift of the Dell shares under Section 2511 or the step transaction doctrine. The court rejected the IRS’s argument that the partnership and the gifts should be collapsed into a single transaction, noting the economic risk the Holmans bore due to the potential change in the value of the partnership between the funding and the gifts.

    Regarding the transfer restrictions, the court found that they did not constitute a bona fide business arrangement under Section 2703(b)(1) because their primary purpose was to discourage the children from dissipating their wealth, rather than serving a legitimate business purpose. The court also determined that the restrictions were a device to transfer property to family members for less than full consideration under Section 2703(b)(2), as they allowed for the redistribution of wealth among the children if an impermissible transfer occurred.

    In valuing the gifts, the court applied minority interest discounts based on the interquartile mean of discounts observed in samples of closed-end investment funds, rejecting the Holmans’ expert’s adjustments for lack of portfolio diversity and professional management. The court also applied a marketability discount of 12. 5%, finding that the Holmans’ expert’s approach was unsupported and that the IRS’s expert provided a more reliable estimate, taking into account the potential for a private market among the partners for LP units.

    Disposition

    The court determined the fair market values of the gifts after applying the appropriate discounts and entered a decision under Rule 155, allowing the parties to compute the final tax liabilities based on the court’s findings.

    Significance/Impact

    Holman v. Comm’r is significant for its analysis of indirect gifts and valuation discounts in the context of family limited partnerships. The case clarifies that the timing and economic risk associated with transfers to an FLP and subsequent gifts of partnership interests can affect whether they are treated as indirect gifts. The court’s decision to disregard transfer restrictions under Section 2703 also impacts how FLPs can be structured for estate planning and tax purposes, emphasizing the importance of having bona fide business purposes for such restrictions. The case’s valuation methodology, particularly the use of closed-end investment fund data and the consideration of a private market for partnership interests, provides guidance for practitioners in valuing gifts of FLP interests.

  • Estate of Bongard v. Comm’r, 124 T.C. 95 (2005): Application of Sections 2035 and 2036 in Family Limited Partnership Context

    Estate of Wayne C. Bongard, Deceased, James A. Bernards, Personal Representative, Petitioner v. Commissioner of Internal Revenue, Respondent, 124 T. C. 95 (2005)

    The U. S. Tax Court’s ruling in Estate of Bongard clarified the application of Sections 2035 and 2036 to family limited partnerships, distinguishing between bona fide sales and testamentary transfers. Decedent’s transfer of Empak stock to WCB Holdings was upheld as a bona fide sale, motivated by positioning the company for a corporate liquidity event. However, his transfer to the Bongard Family Limited Partnership (BFLP) failed to meet this exception due to lack of significant non-tax motives, resulting in the inclusion of certain assets in his estate. This decision underscores the importance of demonstrating legitimate business purposes in estate planning to avoid estate tax inclusion.

    Parties

    The Petitioner was the Estate of Wayne C. Bongard, with James A. Bernards serving as the Personal Representative. The Respondent was the Commissioner of Internal Revenue.

    Facts

    In 1980, Wayne C. Bongard (Decedent) incorporated Empak, Inc. In 1986, he established the Wayne C. Bongard Irrevocable Stock Accumulation Trust (ISA Trust), transferring 15% of Empak’s stock into it. By the mid-1990s, to position Empak for a corporate liquidity event, Decedent and ISA Trust transferred their Empak stock to WCB Holdings, LLC (WCB Holdings), receiving membership units in return. Subsequently, Decedent transferred his WCB Holdings Class B units to the Bongard Family Limited Partnership (BFLP) in exchange for a 99% limited partnership interest. In 1997, Decedent gifted a 7. 72% interest in BFLP to his wife, Cynthia Bongard. Decedent died unexpectedly in 1998, and his estate was challenged on the tax treatment of these transfers by the IRS.

    Procedural History

    The IRS issued a notice of deficiency on February 4, 2003, to Decedent’s estate, asserting that the Empak shares transferred to WCB Holdings should be included in Decedent’s gross estate under Sections 2035(a) and 2036(a) and (b). The estate filed a timely petition with the U. S. Tax Court, contesting the IRS’s determination. The case was reviewed by the Tax Court, where the estate argued that both transfers to WCB Holdings and BFLP constituted bona fide sales for adequate and full consideration. The Tax Court, applying a de novo standard of review, heard the case and issued its opinion on March 15, 2005.

    Issue(s)

    Whether Decedent’s transfer of Empak stock to WCB Holdings and his subsequent transfer of WCB Holdings Class B units to BFLP constituted bona fide sales for adequate and full consideration under Section 2036(a)?

    Whether Decedent retained an interest in the transferred property under Sections 2036(a) and 2035(a) that would necessitate the inclusion of the transferred assets in his gross estate?

    Rule(s) of Law

    Section 2036(a) of the Internal Revenue Code includes in a decedent’s gross estate the value of any property transferred if the transferor retains certain rights or interests in the property, unless the transfer was a bona fide sale for adequate and full consideration in money or money’s worth. Section 2035(a) includes in the gross estate property transferred within three years of death if such property would have been included under Section 2036 had the transferor retained it until death.

    Holding

    The Tax Court held that Decedent’s transfer of Empak stock to WCB Holdings satisfied the bona fide sale exception of Section 2036(a) due to a legitimate and significant non-tax business purpose of positioning Empak for a corporate liquidity event. However, the transfer of WCB Holdings Class B units to BFLP did not satisfy the bona fide sale exception, as it lacked a significant non-tax motive. The court further found that an implied agreement existed allowing Decedent to retain enjoyment of the property held by BFLP, necessitating the inclusion of the WCB Holdings Class B units in Decedent’s gross estate under Section 2036(a)(1). Consequently, the 7. 72% BFLP interest gifted to Cynthia Bongard within three years of Decedent’s death was also included in the estate under Section 2035(a).

    Reasoning

    The court applied a two-pronged test for the bona fide sale exception in the context of family limited partnerships: (1) the existence of a legitimate and significant non-tax reason for the transfer, and (2) the transferor receiving partnership interests proportionate to the value of the property transferred. For the transfer to WCB Holdings, the court found that positioning Empak for a corporate liquidity event was a legitimate business purpose, satisfying the first prong. The second prong was met as Decedent received WCB Holdings membership units proportionate to his contribution of Empak stock.

    Conversely, the transfer to BFLP failed the first prong as no significant non-tax reason was evident; the court found it primarily motivated by tax benefits. The court also identified an implied agreement allowing Decedent to retain enjoyment of the property transferred to BFLP, based on his ability to influence the redemption of Empak stock and WCB Holdings units, which could affect BFLP’s liquidity. This retention of enjoyment triggered the application of Section 2036(a)(1).

    Disposition

    The court’s decision partially overruled the Commissioner’s notice of deficiency, excluding the value of Empak stock transferred to WCB Holdings from Decedent’s gross estate but including the value of WCB Holdings Class B units transferred to BFLP and the portion gifted to Cynthia Bongard.

    Significance/Impact

    The Estate of Bongard decision clarified the criteria for the bona fide sale exception under Section 2036(a) in the context of family limited partnerships. It emphasized the necessity of demonstrating legitimate and significant non-tax business purposes for such transfers to avoid estate tax inclusion. This ruling has had a significant impact on estate planning strategies involving family limited partnerships, influencing subsequent judicial interpretations and prompting practitioners to carefully document non-tax motives for entity formations and transfers.

  • Knight v. Commissioner, 115 T.C. 506 (2000): Valuing Family Limited Partnership Interests for Gift Tax Purposes

    Knight v. Commissioner, 115 T. C. 506 (2000)

    The fair market value of gifts of family limited partnership interests must consider appropriate discounts for minority interest and lack of marketability.

    Summary

    In Knight v. Commissioner, the Tax Court recognized a family limited partnership for federal gift tax purposes and upheld the validity of applying discounts when valuing gifts of partnership interests. Herbert and Ina Knight formed a partnership, transferring assets including real property and securities, and gifted 22. 3% interests to trusts for their children. The court determined that a 15% discount for minority interest and lack of marketability was appropriate, valuing each gift at $394,515. The decision clarified that the economic substance doctrine does not apply to disregard partnerships recognized under state law in gift tax valuation, impacting how similar estate planning strategies are evaluated.

    Facts

    In December 1994, Herbert and Ina Knight created a family limited partnership, transferring assets valued at $2,081,323, including a ranch, two residential properties, and financial assets. They established a management trust as the general partner and gifted 22. 3% interests in the partnership to trusts for their adult children, Mary and Douglas. The partnership operated passively, with the Knights retaining control over management. The gifts were reported on their federal gift tax returns, and the IRS challenged the valuation, arguing for a higher value without recognizing the partnership.

    Procedural History

    The IRS issued notices of deficiency to the Knights, asserting gift tax deficiencies due to undervaluation of the gifts. The Knights petitioned the Tax Court, which consolidated their cases. The court heard arguments on whether to recognize the partnership for gift tax purposes and the appropriate valuation discounts. The court ultimately recognized the partnership and determined the applicable discounts.

    Issue(s)

    1. Whether the family limited partnership should be disregarded for federal gift tax valuation purposes.
    2. Whether portfolio, minority interest, and lack of marketability discounts totaling 44% apply to the valuation of the gifts.
    3. What is the fair market value of each gift made by the Knights to their children’s trusts?
    4. Whether section 2704(b) of the Internal Revenue Code applies to the transaction.

    Holding

    1. No, because the partnership was valid under Texas law and should not be disregarded based on the economic substance doctrine.
    2. No, because the portfolio discount was not supported by evidence, but a 15% discount for minority interest and lack of marketability was appropriate.
    3. The fair market value of each gift was $394,515, reflecting the 22. 3% interest in the partnership’s assets after applying a 15% discount.
    4. No, because the partnership agreement’s restrictions were not more restrictive than those under Texas law, as established in Kerr v. Commissioner.

    Court’s Reasoning

    The court recognized the partnership for gift tax purposes because it was valid under Texas law and the economic substance doctrine was not applicable to disregard it. The court rejected the portfolio discount due to lack of evidence but found that a 15% discount for minority interest and lack of marketability was appropriate, considering the partnership’s similarity to a closed-end fund. The court emphasized that the willing buyer, willing seller test is used to value the partnership interest, not to determine the partnership’s validity. The court also found that section 2704(b) did not apply because the partnership agreement’s restrictions were not more restrictive than those under Texas law, following the precedent set in Kerr v. Commissioner.

    Practical Implications

    Knight v. Commissioner provides guidance on valuing family limited partnership interests for gift tax purposes, affirming that such partnerships can be recognized if valid under state law. The decision clarifies that while the economic substance doctrine may not be used to disregard these partnerships, appropriate discounts for minority interest and lack of marketability must be considered in valuation. This impacts estate planning strategies involving family limited partnerships, as taxpayers can utilize these discounts to reduce gift tax liabilities. The ruling also reinforces the application of state law in determining the validity of partnerships and the limitations on using section 2704(b) to challenge partnership restrictions. Subsequent cases, such as Estate of Thompson v. Commissioner, have cited Knight in determining similar valuation issues.

  • Estate of Strangi v. Commissioner, 115 T.C. 478 (2000): When Family Limited Partnerships Are Recognized for Estate Tax Purposes

    Estate of Albert Strangi, Deceased, Rosalie Gulig, Independent Executrix v. Commissioner of Internal Revenue, 115 T. C. 478 (2000)

    A family limited partnership is recognized for estate tax purposes if it has sufficient economic substance, despite lacking a valid business purpose.

    Summary

    Albert Strangi transferred assets to a family limited partnership (SFLP) two months before his death, receiving a 99% limited partnership interest. The IRS argued that SFLP should be disregarded for estate tax purposes due to lack of business purpose and economic substance. The Tax Court recognized the partnership for tax purposes due to its validity under state law and the economic substance it possessed, despite finding no valid business purpose. The court applied valuation discounts to Strangi’s interest, rejecting a gift tax argument on the transfer to the partnership. This case highlights the importance of economic substance over business purpose in determining the validity of family limited partnerships for estate tax purposes.

    Facts

    Albert Strangi, a multimillionaire, formed the Strangi Family Limited Partnership (SFLP) in 1994, two months before his death. He transferred assets valued at $9,876,929, including cash, securities, real estate, insurance policies, and partnership interests, to SFLP in exchange for a 99% limited partnership interest. Stranco, Inc. , a corporate general partner owned by Strangi and his children, managed SFLP. After Strangi’s death, SFLP made substantial distributions to his estate and children, indicating continued control over the assets.

    Procedural History

    The IRS determined a deficiency in Strangi’s estate tax, arguing that SFLP should be disregarded due to lack of business purpose and economic substance. The estate contested this, and the case proceeded to the U. S. Tax Court. The Tax Court recognized SFLP for tax purposes but applied valuation discounts to Strangi’s interest, leading to a decision on the estate’s value.

    Issue(s)

    1. Whether the Strangi Family Limited Partnership (SFLP) should be disregarded for Federal estate tax purposes due to lack of business purpose and economic substance?
    2. Whether the SFLP agreement constitutes a restriction on the sale or use of property that should be disregarded under section 2703(a)(2)?
    3. Whether the transfer of assets to SFLP constituted a taxable gift?
    4. If SFLP is not disregarded, what is the fair market value of Strangi’s interest in SFLP at the date of death?

    Holding

    1. No, because SFLP, although lacking a valid business purpose, had sufficient economic substance to be recognized for tax purposes.
    2. No, because section 2703(a)(2) does not apply to the partnership agreement, as the property included in the estate is the partnership interest, not the underlying assets.
    3. No, because the transfer did not constitute a taxable gift, as Strangi’s beneficial interest in the partnership exceeded 99%, and contributions were reflected in his capital account.
    4. The fair market value of Strangi’s interest in SFLP at the date of death, after applying valuation discounts, was determined to be $6,560,730.

    Court’s Reasoning

    The court applied the economic substance doctrine, finding that SFLP had sufficient economic substance to be recognized for tax purposes despite lacking a valid business purpose. The court noted that SFLP was validly formed under state law, and its existence would not be disregarded by potential purchasers. The court rejected the IRS’s argument that the partnership lacked economic substance due to its tax-avoidance purpose, as the assets were managed and distributed post-formation. The court also rejected the application of section 2703(a)(2), stating that the property to be valued was Strangi’s partnership interest, not the underlying assets. The court found no taxable gift at the inception of SFLP, as Strangi’s beneficial interest exceeded 99%, and the transfer was reflected in his capital account. The valuation of Strangi’s interest was determined using the net asset value approach, applying discounts for lack of marketability and minority interest.

    Practical Implications

    This decision emphasizes that family limited partnerships may be recognized for estate tax purposes even if they lack a valid business purpose, as long as they have economic substance. Practitioners should focus on ensuring that such partnerships have a genuine economic impact, as the court will look beyond stated business purposes. The ruling also clarifies that section 2703(a)(2) does not apply to disregard the partnership agreement when valuing partnership interests for estate tax purposes. This case may encourage taxpayers to use family limited partnerships for estate planning, as long as they can demonstrate economic substance. Subsequent cases have referenced this decision when evaluating the validity of family limited partnerships for tax purposes.

  • Estate of Reichardt v. Commissioner, 114 T.C. 144 (2000): When Transfers to Family Limited Partnerships Are Included in the Gross Estate

    Estate of Reichardt v. Commissioner, 114 T. C. 144 (2000)

    The value of property transferred to a family limited partnership is includable in the transferor’s gross estate under IRC section 2036(a) if the transferor retains possession, enjoyment, or the right to income from the transferred property.

    Summary

    Charles E. Reichardt transferred nearly all his assets to a family limited partnership but retained control and use of the property, including living rent-free in his transferred residence. The Tax Court held that these assets were includable in his gross estate under IRC section 2036(a) because he retained possession, enjoyment, and the right to income from the transferred property. The court rejected arguments that the transfers were bona fide sales for adequate consideration and found that the decedent’s continued use of the property indicated an implied agreement to retain economic benefits, despite the formal transfer of legal title.

    Facts

    Charles E. Reichardt formed a revocable family trust and a family limited partnership in 1993, shortly after his wife’s death. He transferred nearly all his assets to the partnership through the trust, including his residence, rental properties, and investment accounts. Reichardt retained control over the partnership as the sole active trustee and general partner, managing and using the assets as he had before the transfer. He lived rent-free in his transferred residence and continued to manage the partnership’s assets, including investment accounts and a note receivable, without any change in his relationship to the assets. In October 1993, Reichardt gifted a 30. 4% limited partnership interest to each of his two children. He died in August 1994.

    Procedural History

    The Commissioner of Internal Revenue determined deficiencies in gift and estate taxes, arguing that the transferred assets should be included in Reichardt’s gross estate under IRC section 2036(a). The Estate of Reichardt challenged this determination in the United States Tax Court. After concessions by the Commissioner, the Tax Court focused solely on whether the assets were includable under section 2036(a).

    Issue(s)

    1. Whether the assets transferred to the partnership are included in Reichardt’s gross estate under IRC section 2036(a)?

    2. Whether the transfer of assets to the partnership was a bona fide sale for full and adequate consideration?

    Holding

    1. Yes, because Reichardt retained possession, enjoyment, and the right to income from the transferred assets during his lifetime, indicating an implied agreement to continue using the property.
    2. No, because Reichardt’s children did not provide any consideration for the transferred assets, and the transfer was not an arm’s-length transaction.

    Court’s Reasoning

    The court applied IRC section 2036(a), which requires inclusion in the gross estate of property transferred during life if the transferor retains possession, enjoyment, or the right to income from the property. The court found that despite the formal transfer of legal title to the partnership, Reichardt’s relationship to the assets remained unchanged. He continued to live in his residence without paying rent, managed the partnership’s assets, and used partnership funds for personal expenses. The court concluded that this indicated an implied agreement between Reichardt and his children to allow him to retain the economic benefits of the property. The court rejected the argument that the transfers were for full and adequate consideration, noting that Reichardt’s children provided no consideration and that the partnership was not a bona fide sale. The court also distinguished the case from others where similar transfers were upheld, emphasizing the lack of change in Reichardt’s control and use of the property.

    Practical Implications

    This decision reinforces the principle that transfers to family limited partnerships will be scrutinized under IRC section 2036(a) to determine if the transferor retains economic benefits of the transferred property. Attorneys advising clients on estate planning should ensure that transfers to family limited partnerships are structured to genuinely relinquish control and use of the assets, or face the risk of inclusion in the gross estate. The case highlights the importance of documenting bona fide sales and ensuring that family members provide adequate consideration to avoid section 2036(a) issues. Practitioners should also be aware of the potential for the IRS to challenge such transfers, particularly when the transferor continues to use the property as before. Subsequent cases have cited Reichardt in analyzing similar transfers, emphasizing the need for a clear break in control and use to avoid estate tax inclusion.

  • Kerr v. Commissioner, 113 T.C. 449 (1999): When Partnership Liquidation Restrictions Are Not Applicable for Valuation Purposes

    Kerr v. Commissioner, 113 T. C. 449 (1999)

    Restrictions on partnership liquidation in partnership agreements are not applicable for valuation purposes if they are no more restrictive than those under state law.

    Summary

    In Kerr v. Commissioner, the petitioners created family limited partnerships and transferred interests to grantor retained annuity trusts (GRATs) and their children. The IRS argued that the partnership agreements’ restrictions on liquidation should be disregarded under IRC section 2704(b), which could increase the taxable value of the transferred interests. The Tax Court held that the interests transferred to the GRATs were limited partnership interests, not assignee interests. However, it granted summary judgment to the petitioners on the section 2704(b) issue, ruling that the partnership agreements’ liquidation restrictions were not more restrictive than those under Texas law and thus not applicable restrictions for valuation purposes.

    Facts

    Baine P. Kerr and Mildred C. Kerr formed the Kerr Family Limited Partnership (KFLP) and Kerr Interests Limited Partnership (KILP) under Texas law. They transferred life insurance policies and other assets to these partnerships. The Kerrs then transferred limited partnership interests to their GRATs and their children. The partnership agreements stipulated that the partnerships would dissolve and liquidate on December 31, 2043, or by agreement of all partners. The IRS issued notices of deficiency, arguing that the liquidation restrictions in the partnership agreements should be disregarded under section 2704(b), thereby increasing the taxable value of the transferred interests.

    Procedural History

    The Kerrs filed a joint petition for redetermination with the Tax Court, challenging the IRS’s determinations. They moved for partial summary judgment, arguing that the transferred interests were assignee interests and that section 2704(b) did not apply. After conceding that the interests transferred to their children were limited partnership interests, the Kerrs maintained that all interests should be valued as assignee interests. The court granted the Kerrs’ motion for leave to amend their petition to raise the assignee issue and subsequently held hearings and received testimony on the matter.

    Issue(s)

    1. Whether the interests transferred to the GRATs were limited partnership interests or assignee interests.
    2. Whether the partnership agreements’ restrictions on liquidation constituted applicable restrictions under section 2704(b).

    Holding

    1. No, because the Kerrs, in substance and form, transferred limited partnership interests to the GRATs.
    2. No, because the partnership agreements’ restrictions on liquidation were not more restrictive than those under Texas law, and thus not applicable restrictions under section 2704(b).

    Court’s Reasoning

    The court applied the substance over form doctrine, finding that the Kerrs transferred limited partnership interests to the GRATs despite the absence of formal consents from their children. The court noted the similarity in rights between limited partners and assignees under the partnership agreements and the tax motivation behind structuring the transfers as assignee interests. Regarding the section 2704(b) issue, the court compared the partnership agreements’ liquidation provisions with Texas law, concluding that the agreements’ restrictions were no more restrictive than those under state law. Therefore, the restrictions did not constitute applicable restrictions under section 2704(b). The court rejected the IRS’s argument that a different Texas statute on partner withdrawal should be considered, as it did not pertain to partnership liquidation.

    Practical Implications

    This decision clarifies that partnership agreements’ restrictions on liquidation will not be disregarded under section 2704(b) if they are no more restrictive than those under state law. Practitioners should carefully compare partnership agreement provisions with applicable state law when structuring transfers of partnership interests. The case also reinforces the substance over form doctrine’s application in determining the nature of transferred interests. Subsequent cases, such as Estate of Strangi v. Commissioner, have distinguished Kerr, applying section 2704(b) when partnership agreements’ restrictions were more restrictive than state law.