The tax court case of Estate of Powell v. Commissioner is the first court case in 12 to address estate planning regarding Family Limited Partnerships (FLPs) and Limited Liability Companies (LLCs).
The facts of the case start with the decedent’s son, acting on her behalf under a power of attorney, transferred $10 million into a FLP in return for 99% of limited partnership interest. Her two sons contributed unsecured notes for a 1% interest in the company as general partners. The son then transferred the decedents 99% interest in the FLP into a Charitable Lead Annuity Trust (CLAT) which would pay an annuity to charity for the decedent’s life with the remainder passing to the decedent’s two sons. Seven days after these transactions took place, she died. The IRS claimed that the $10 million of assets contributed to the FLP were includible in the decedent’s estate.
The argument made by the IRS centered around code section §2035(a), §2036(a)(2) and §2043. §2035(a) states that any transfer made by the decedent of interest in any property or relinquishment of power with respect to the property, during a 3-year period ending on the date of the descendants death and the value of the property would have been included in the gross estate under §2036, 2037, 2038, 2042 if the transferred interest or relinquished power had been retained by the decedent on the date of death then the value of the gross estate would include the value of that property. Since the transfer of property occurred 7 days before the death of the decedent §2035(a) would have applied and the estate would have picked up the value of the $10 million of assets. This rule has never been in question and new ground was broken with this ruling.
This case is important because of §2036(a)(2) and §2043. §2036(a)(2) states that the value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer and retained for the remainder of their life the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income. Prior to this case, interest transferred to a limited partnership was deemed to be out of the control of the decedent and therefore the value would not be included in the estate. The court, in this case, ruled that since the FLP “in conjunction with” all of the other partners could dissolve the partnership at any time, that the decedent retained the control to designate the persons who shall possess or enjoy the property or the income. Therefore the $10 million transferred to the FLP would be included in the value of the estate. The court did not stipulate that the limited partner’s percentage owned factored into the case, but the reasoning allowing the ability to dissolve the entity by acting “in conjunction with” other partners would not change based on the amount of LP interest owned by the decedent.
The other reason this case is important is §2043. §2043 states that if any one of the transfers, trusts, interests, rights, or powers enumerated and described in sections 2035 to 2038, inclusive, and section 2041 is made, created, exercised, or relinquished for a consideration in money or money’s worth, but is not a bona fide sale for an adequate and full consideration in money or money’s worth, there shall be included in the gross estate only the excess of the fair market value at the time of death of the property. To put in layman terms, if the sale of or transfer of assets is not for a legitimate or taxable reason then the appreciation of the assets will be added back on top of the original consideration. In this case, the decedent died 7 days after the creation of the FLP and the assets were deemed to be the same value as the day of contribution. Therefore, there was no appreciation in value.
The tax court ruled in favor of the IRS in this case, which set the precedence of allowing §2036(a)(2) to be applied to FLPs. This recent Tax Court case could be considered as an example where ‘bad facts make bad law. In addition, it emphasizes the importance of proper implementation and monitoring when executing certain estate planning transactions. We will be monitoring this case to see if the estate will appeal the decision of the Tax Court and the resulting appellate rulings. Please contact your Withum tax advisor to see how this recent Tax Court decision impacts your personal estate planning.