After a slew of “bad facts” cases concerning family limited partnerships (FLPs), the latest opinion by the U.S. Tax Court, Estate of Miller v. Commissioner (May 27, 2009), provides an interesting “split” decision for the taxpayer, in which one FLP asset transfer successfully escapes the pull of IRC Sec. 2036—but the other does not. What made the difference?
In this case, the Miller FLP was comprised of marketable securities worth over $3.8 million. After its formation and funding in 2002, an appraisal for gift tax purposes applied a 35% discount for lack of marketability. Within a year, however, Mrs. Miller was diagnosed with a terminal illness. Her son—also the FLP’s managing partner—caused her to transfer all remaining assets (about $900,000) into the partnership. When she died a few weeks later, her estate valued the FLP at $2.59 million, after application of the 35% discount, and used some of the assets to pay estate taxes. The IRS assessed over $500,000 in deficiencies and the estate sued for a refund.
The IRS didn’t contest the 35% discount, but instead argued that the taxable estate should include the full value of the FLP per IRC Sec. 2036(a). The FLP served no legitimate and substantial, non-tax purpose, it said, citing the “bad facts” in Estate of Stone (2003), Estate of Bongard (2005), Estate of Hurford (2008), and Estate of Jorgensen (2009).
But the estate claimed the FLP served several legitimate purposes, chief among them the continuation of the family’s specific investment strategy—and the Tax Court agreed, at least insofar as the initial funding was concerned. Citing Estate of Mirowkski (2008), the court held that an FLP’s activities “need not rise to the level of a ‘business’ under the Federal income tax laws in order for the [bona fide transfer] exception under section 2036(a) to apply.” The first asset transfer did not deplete the founder’s assets and the stock portfolio was actively managed by the son. By contrast, the driving force behind the May 2003 transfers was the precipitous decline in Mrs. Miller’s health, the desire to reduce her taxable estate, and to pay her estate taxes. Accordingly, this second funding did not escape the reach of Sec. 2036(a).
Where can you find all FLP cases, the good and the bad? A complete abstract of the Miller case will appear in the next (August 2009) Business Valuation Update™. In addition, copies of all important FLP court decisions are currently available to subscribers of BVLaw™.