The last case of Estate of Fields v. CommissionerTC 2024-90 (Tax Ct. 9-26-24), provides a text example of a family limited partnership (FLP) with bad facts that triggered estate tax inclusion of property transferred to the FLP under Code section 2036 of Internal Revenue. (a)(1) and (2) with loss of deductions for lack of control and lack of marketability. The court applied the Tax Court's holding in 2017 Estate of Powell v. Comm'r148 TC 392 (2017), which held that the decedent's ability as a limited partner to join with other partners to liquidate the FLP constituted a Section 2036(a)(2) estate tax trigger IRC and increases the accuracy spectrum -related penalties.
Businesswoman appoints successor
Anne Milner Fields inherited an oil business when her husband died in the 1960s. She ran the business well and, in time, became a successful businesswoman. She took a special interest in her great grandson, Bryan Milner, educating him, mentoring him and appointing him as successor to her estate. In her later years, she relied on Bryan to care for her and manage her assets, entrusting him with a general durable power of attorney. Bryan ultimately exercised this POA to implement an estate plan involving an FLP about a month before Anne's death on June 23, 2016.
Limited partnership formed
On May 20, 2016, Bryan formed AM Fields Management, of which he was the sole member and manager. He then formed AM Fields on May 26, 2016, of which AM Fields Management was the general partner and Anne was the limited partner. In forming AM Fields, Bryan entered into the partnership agreement as manager of AM Fields Management and as Anne's agent under her POA with respect to her LP interest. He then used his POA to transfer approximately $17 million of Anne's assets (comprising more than 85% of her estate) to AM Fields. He also had AM Fields Management contribute $1,000 to AM Fields as its capital contribution. In exchange for partnership contributions, Anne received a 99.9941% LP interest in AM Fields, and AM Fields Management received a 0.0059% GP interest.
After Anne died, Bryan received an appraisal of Anne's LP interest in AM Fields. The appraiser valued the interest at $10.8 million on Anna's date of death, reducing the approximately $17 million in assets she contributed to FLP approximately one month before her death with a total discount of 36.25% for lack of control and lack of marketability. As executor of Anne's estate, Bryan reported this reduced value on the estate's Form 706 estate tax return.
Notice of deficiency issued
The IRS audited the estate tax return and attacked the deduction claimed under section 2036(a)(1) and (2). In a Notice of Deficiency, the IRS asserted that section 2036(a) applies so that the gross estate includes the full value at the date of death of Anne's assets that were contributed to AM Fields without any deduction for lack of control or lack of marketability. The IRS also asserted an exaction penalty against the estate under IRC Sections 6662(a) and (b)(1) due to negligence or failure to comply with rules or regulations. Litigation in the Tax Court followed.
Section 2036 Analysis
The Tax Court observed that there are three requirements for property to be included in the gross estate under section 2036(a): (1) the decedent must have made an inter vivos transfer of the property (which was undisputed here); (2) the decedent must have retained an interest or right specified in section 2036(a)(1) or (2) in the transferred property which he did not relinquish until his death; and (3) the transfer must not constitute a bona fide sale for adequate and full consideration.
Interest retained under section 2036(a)(1)
The court had little difficulty finding that Anne held an interest in the property she transferred to FLP under section 2036(a)(1). As a result of Bryan's dual role as attorney-in-fact under Anne's POA and as manager of the GP, Anne was entitled to income from her transferred assets. The court also found that Anne and Bryan implicitly agreed that Bryan would make distributions from the partnership to satisfy Anne's expenses, debts and trusts. This was evidence of Anne's retained interest in the assets transferred to the partnership. The court considered the $1,000 GP interest that AM Fields earned in FLP to be de minimis, so it did not create a pool of interest to potentially alter this result.
The right to determine the enjoyment of the property is reserved
Relying on Powell, the court then held that estate tax inclusion was also triggered under section 2036(a)(2) because it preserved Anne's right, as the LP, to act jointly with the GP to dissolve the FLP in and to cause its liquidation.
Section 2036 bona fide sale exception Not available
The court then considered whether Section 2036's exception for transfers that constitute a “good faith sale for adequate and full consideration in money or money's worth” could spare the taxpayer from the reach of Section 2036. This exception requires full consideration and adequate for inter vivos transfer and a “good faith sale”. The bona fide sale field, on the other hand, requires a “substantial non-tax purpose.”
Relying primarily on Bryan's testimony, the estate argued that there were four essential non-tax purposes behind Anna's capital contributions to FLP:
1. FLP protected Anne from further financial elder abuse cases (which she had sustained several years earlier).
2. The FLP permitted successor management of the assets by allowing Bryan to appoint his successor.
3. The FLP resolved concerns that third parties, such as banks, might refuse to honor Anne's POA (which had occurred several years earlier).
4. FLP allows consolidated and efficient asset management.
The court found Bryan's testimony that Anne was in fact motivated by any of the above four objectives to contribute her assets to FLP unreliable. Rather, the court found that the creation of the FLP was motivated by a desire to save estate taxes and specifically considered showing an email from Bryan's attorney to the assessor requesting “taking a deeper deduction” for tax purposes. Further, the timeline for the establishment and funding of the FLP coincided with Anna's rapidly declining health, as she suffered from severe Alzheimer's disease and died approximately one month after the partnership was funded. Additionally, the transfers of assets to the FLP depleted Anna's liquidity to the point that the estate could not pay Anna's bequests under her will or her estate tax liability without receiving substantial distributions from the FLP. Based on these circumstances, the court ruled that the stated intentions of the taxes were post hoc “theoretical reasons” and not “actual motivations.” Therefore, the estate failed to meet its burden of proof that the transfers to FLP constituted bona fide sales to qualify for the section 2036 exemption.
Article 2036 inclusion amount
The court then addressed the amount of inclusion of section 2036 and relied on it Moore's EstateMemo TC. 2020-40 (2020) for its analysis. below Moorethe date-of-death value of both the limited partnership interest (under Section 2033) and the transferred partnership property (under Section 2036) must be taken into account and then offset against it under Section 2043(a) the value of the partnership property transferred as of the date of transfer. Because neither party argued that there was an appreciation or depreciation in the value of the transferred property between the date of transfer and the date of death, the components of section 2033 and section 2043(a) canceled each other out, producing estate tax inclusion. of the date -death value of the property transferred without any deduction.
Accuracy penalty
Finally, the court reviewed the IRS's imposition of a 20% accuracy-related penalty under IRC sections 6662(a) and (b)(1) on the underpayment of estate tax required to be reported on the estate tax return due to negligence. or failure to comply with rules or regulations. Section 6662(c) provides that the term “negligence” includes any failure to make a reasonable effort to comply with the IRC, and the term “disregard” includes any reckless, reckless, or willful disregard.
In his capacity as executor, the estate argued that Bryan had reasonable cause for any underpayment and acted in good faith in determining the estate's tax liability. The court rejected this contention because Bryan never alleged that he personally considered, researched, or understood the implications of section 2036 on estate tax liability. Moreover, the record did not show that Bryan relied in good faith on the judgment of counsel in deducting the value of Anne's LP interest without regard to the application of section 2036. Therefore, the estate failed to discharge the burden her to establish reasonable cause and was therefore liable for the 20% accuracy-related penalty for the underpayment of property tax.