Summer has arrived, and the Middle Fork of Idaho's Clearwater River, running by our home in North Idaho, is running high - to the delight of kayakers and rafters! And even though in April, the Trump Administration briefly outlined its "tax reform plan", we as yet have not seen a House Ways & Means Committee tax bill! So all seems to stay in flux, especially as President's Trump's tweets continue to confound his supporters and detractors alike!
Upcoming Fiore Webinar - "FAMILY WEALTH & MANAGEMENT SUCCESSION PLANNING" - sponsored by Eli Financial, www.elifinancial.com, and being presented on June 20th. As many of my readers are aware, my various courses online all deal with estate and succession planning. This new course, including over 50 power point slides, a detailed memo of 26 pages on succession planning, a succession planning case study and the usual Selected Bibliography, will show attendees how to get into this area of planning and why it is so important for CPAs and other tax professionals to do so. Learn from the course on June 20th my 10 Steps in Successful Succession Planning, a proactive approach to helping client families preserve for generations their family business enterprises and their investment portfolios.
Tax Court Revisits IRC Sec. 2036(a): Estate of Nancy H. Powell v. Commissioner, 148 T.C. No. 18 (5/18/17) -
I have been a long-time commentator for Leimberg Information Services, Inc. (LISI), my friend Steve Leimberg's wonderful online service for tax professionals, including a series of email Newsletters that include commentaries by professionals on current law and tax developments. See the LISI website for Email Newsletter Archive Message #2556 (6/1/17), which I authored : "Owen Fiore on Estate of Powell: Tax Court Again Rejects Deathbed Use of the Value-Discounting FLP to Reduce Estate Tax."
IRC Sec. 2036(a) essentially requires inclusion in a decedent's estate of property he or she transferred during lifetime but retained undue control over, or beneficial enjoyment from, the transferred assets. Here we are dealing with pass-through entities, such as the family limited partnership (FLP) or family limited liability company (FLLC) as the receptacle for the asset transfer during lifetime. Now some 40 Tax Court cases have been decided and opinions issued, the first of which, way back in 1997, was my own case in which I was the estate's tax litigation counsel: Estate of Dorothy Schauerhamer v. Commissioner, 1997 T.C. Memo. 242. Obviously, the law has developed considerably since 1997, and generally so-called "deathbed transfer tax avoidance plans" have been found wanting under 2036(a). The Powell case opinion not only is the latest in this long series of decisions, but also, being a regular or reviewed opinion of the entire Tax Court, is a significant decision - and various judges had quite different views!
As the court majority opinion, authored by Judge Halpern, stated: "The combined effect of Section 2036(a)(2), Section 2035(a), Section 2043(a) and either Section 2033 or Section 2038(a) would be to include in the value of the decedent's gross estate the value, as of the date of her death (one week after the planning was put in place), of the cash and securities he (decedent's investment manager son) transferred to NHP (the FLP)". So let's see the facts of this case, the majority and concurring opinions in the Tax Court, and what lessons should be learned from this latest anti-FLP judicial decision.
Facts Matter!
What is involved in the Powell case, involving a decedent in Northern California, was the use of a deathbed FLP as an estate tax savings strategy (a 25% valuation discount was opined by Duff & Phelps, a valuation firm), coupled with what turned out to be a failed attempt at a Charitable Lead Annuity Trust (CLAT) intended - one week before decedent's death! - to eliminate decedent's FLP partnership interest (99% limited interest) from her gross estate at death.
Nancy Powell died on August 8, 2008, and her executor was one of two sons who were her estate beneficiaries. After obtaining medical opinions to the effect mother was incapacitated, and thus triggering his position as her attorney-in-fact for asset management, and also being the trustee of mother's revocable trust, son Jeffrey Powell, an investment manager whose firm managed Nancy's $10 million of cash and securities, transferred the assets to NHP Enterprises LP, an FLP. The partnership agreement, under which Jeffrey was general partner and his mother was the 99% limited partner, gave the general partner sole discretion on the amount and timing of all distributions, but also stated that on the written vote of all partners, the partnership could be liquidated.
But Jeffrey was not finished with the deathbed planning! Wanting obviously to eliminate any partnership interest from his mother's gross estate, and acting under her power of attorney, he transferred by gift the entire 99% limited partnership interest to a CLAT in exchange for an annuity to the Nancy H. Powell Private Foundation for her remaining life, following which the assets would go to Jeffrey and his brother.
Death-Bed Use of an FLP Does Not Work - Ever Since Schauerhamer
IRS jumped in, to be expected, and issued proposed deficiency notices for $5.9 million in estate tax and for a 2008 $3 million gift tax. Note, as indicated below, the gift tax deficiency disappeared since the gift was found to be invalid! As to the estate tax, Judge Halpern, with 7 judges joining in his majority opinion, found that under Sec. 2036(a)(2) the value of the cash and securities must be included in Nancy's estate, but - interestingly enough - that under the "consideration offset" rule, the appraisal value of the FLP units received on the asset transfer to the FLP reduced the amount in the estate - by about 75% of the total! However, since the gift was invalid, that 75% FLP interest value nevertheless was includible in decedent's gross estate under either 2033 or 2038(a). The net result was that all $10 million in asset value was indeed in the gross estate for estate tax purposes!
The Failed Charitable Lead Annuity Trust (CLAT)
Facts do really matter, and here California Probate Law came into plan, i.e. what is required under a power-of-attorney for the attorney-in-fact to make a gift of the property owner's assets in that special capacity. The applicable provision here was Probate Code Sec. 4264(c), that an attorney-in-fact does not have authority to make gifts of the person's property unless that authority is expressly provided in the power of attorney itself. And the only express language in the power regarding gifts was limited to those gifts which were within the limits of the IRC Sec. 2503(b) annual exclusion gift provision (even in 2017, only $14,000 per donor, per donee, per year). The estate's efforts to get around this Probate Code provision were totally unsuccessful, as seems clearly appropriate!
The "Consideration Offset" Twist!
For many years now, especially after the case of Bongard v. Commissioner, 124 T.C. 95 (2005), it has seemed clear that, to avoid 2036(a) destroying, in effect, the FLP or FLLC involved, the "full and adequate consideration in money or money's worth" exception to 2036(a) had to be met - namely, by having a real and significant non-tax purpose for the entity, and, second, by the transferor receiving full consideration for the transfer. Rather than determining the case in the vein, Judge Halpern went the "2-step" approach described above, which perhaps was not even necessary. This issue was advanced by Tax Court Judge Lauber, in a concurring opinion (joined in by 6 judges), and Judge Lauber stated: "There are compelling reasons to question whether a valid partnership was ever formed here", and that the majority opinion did not clearly address the "partnership validity" issue.
What's This All Mean?
Well, first note that, in the end, all $10 million in investment assets were part of the gross estate, and the machinations of decedent's son, Jeffrey Powell, and his legal counsel, failed to produce any estate tax reduction. Also, the author recalls the September, 2016 Tax Court opinion in Estate of Beyer v. Commissioner, T.C. Memo. 2016-183, which was a reminder of the fact of tax planning that "bad facts" usually will not win in litigation with IRS!
Therefore, in planning for wealth succession for our clients, we must be realistic and in good faith apply tax law to the client's situation. Sometimes, death-bed planning can be successful in estate value reduction, e.g. co-tenancy gifts of real estate where no FLP or FLLC is even bothered with! CPAs, lawyers and other tax practitioners must be up front with clients on planning, and hopefully usually will have many years to "season" a long-term plan prior to the death of the estate owner.
I hope you have enjoyed this Newsletter, and remember my upcoming Eli Financial webinar, June 20, as well as my CPECredit.com webinars this Fall (see www.cpecredit.com for the schedule of webinars, October - December, 2017).