Estate of Erickson v. Commissioner, T.C. Memo. 2007-107. Is anyone reading Strangi, Rosen, Bongard, or Shepherd?

Another case where the reader of the opinion is left wondering – Why did this case go trial? The results - Bad facts equals the IRS winning another Family Limited Partnership case. However, there is some positive news to come out this case. Rather than relying on ambiguous, nebulous language, Judge Kroupa rolls up his sleeves and delves into the Bongard standards in detail.

The facts in the Estate of Erickson are all too familiar. Decedent’s eldest daughter, (hereinafter the eldest daughter) is the matriarch of the family. She is the power of attorney for the decedent and manages her mother’s financial affairs. Her father left the decedent a credit trust of over a $1 million in assets, consisting of marketable securities as well as a Florida investment condominium. The eldest daughter managed the condominium investment when she took over the financial management of the credit trust. Decedent also had other assets independent of the Credit Trust, which appears the eldest daughter also manages as her mother begins to suffer from Alzheimer’s.

The eldest daughter became aware of the idea of Family Limited Partnership’s and later in the year she and her sister met with a lawyer. The same law firm represented all parties involved and the Family Limited Partnership is entered into. The limited partnership agreement provided as follows:

  • The sisters would be both general partners and limited partners. Decedent, through her eldest daughter’s power of attorney, as well as the eldest daughter’s husband, and the trustees of the credit trust, (the sisters) were limited partners. The eldest daughter then signed the limited partnership agreement in multiple capacities. 
  • The FLP would be funded by decedent contributing securities plus a Florida condominium in exchange for an 86.25-percent interest in the Partnership. 
  • The eldest daughter would contribute two partial interests in a Colorado investment condominium that she and her husband owned in exchange for a general partnership interest and a limited partnership interest, representing 1.4 percent of the Partnership in the aggregate. 
  • Her sister would contribute two partial interests in a Colorado investment condominium she owned in exchange for a general partnership interest and a limited partnership interest, representing 2.8 percent of the Partnership in the aggregate. 
  • The eldest daughter’s husband would contribute a partial interest in the Colorado condominium that they owned in exchange for a 1.4-percent limited partnership interest.
  • Finally, the credit trust would contribute a Florida condominium in exchange for an 8.2-percent limited partnership interest.

Although the agreement provided for the exchanges to be contemporaneous to the execution of the agreement, the exchanges did not occur at that time. Rather, some of the transfers started to occur two months after the agreement was signed. More important, the credit trust did not contribute any of the $1 million in marketable securities it owned to the Partnership.

In September of 2001, decedent’s health rapidly declined. The remaining assets were contributed to the FLP and the eldest daughter, through gifts to decedent’s grandchildren, decreased decedent’s interest in the partnership from 86.25% to 24.18%. At the time of decedent’s death most of her estate, $2 million, was transferred to the FLP and the assets outside of the FLP were illiquid.

The estate did not have sufficient assets to pay the estate tax. To obtain the funds necessary to meet the estate's obligations, the eldest daughter engaged in two transactions. First, she sold decedent’s home to the Partnership for $123,500. Second, the Partnership gave decedent’s estate cash totaling $104,000. The parties characterized the $104,000 disbursement as a redemption of some of decedent’s partnership interests.

In a thorough opinion, the Tax Court found for the IRS under § 2036(a)(1). The Court focused on the two prongs of § 2036(a)(1).

A. Whether Decedent Retained Possession or Enjoyment of the Transferred Property

As to this factor, the Court looked at the factors set forth in Rosen, which were as follows: commingling of funds, a history of disproportionate distributions, testamentary characteristics of the arrangement, the extent to which the decedent transferred nearly all of his or her assets, the unilateral formation of the partnership, the type of assets transferred, and the personal situation of the decedent.

In analyzing these factors, the Court found a retained possession based on the following:

  • The delay in transferring the assets to the Partnership. The Court found that the delay suggested that the parties did not respect the formalities of the Partnership and that the partners were in no hurry to alter their relationship to their assets until decedent's death was imminent. 
  • The Partnership provided the estate with funds to meet its liabilities. The Court found that the disbursal of funds to the estate was tantamount to making funds available to decedent if needed. Second, as to the redemption and acquisition of decedent’s residence, the estate received disbursements at a time that no other partners did. Thus, the Court concluded that these disbursements provide strong support that the estate could use the assets if needed.

    Observation: The Court finally gives guidance as to its views concerning the payment of the estate taxes other than through the decedent’s estate. For those planners that believe a certain type of note will work, take heed of the Court’s observation as to what it believes needs to occur. Other wise that “note” may not work as promised.
  • The partnership was not funded until days before decedent’s death.

Thus, the Court concluded that the partnership was mainly an alternate method through which decedent could provide for her heirs.

B. Bona Fide Sale for Adequate and Full Consideration

The Court acknowledged and applied the Bongard test and its factors - These factors include the taxpayer's standing on both sides of the transaction, the taxpayer's financial dependence on distributions from the partnership, the partners' commingling of partnership funds with their own, and the taxpayer's actual failure to transfer money to the partnership. Just as important the Court acknowledged Schutt.

In Court determined that the sale was not bona fide for adequate and full based on the following:

  • As to the Estate’s argument of centralization of management of the family assets and responsibilities, the Court found that the eldest daughter had already assumed that responsibility and therefore the FLP was not needed. 
  • As to the Estate’s argument of creditor protection, the Court without saying so directly found that a creditor could set aside the partnership when it stated that partnership provided a significant asset base from which to recover over $2 million.

    Observation: Judge Halpren in his concurring opinion in Bongard told the IRS to not concede the validity of the partnership. It appears that Judge Kroupa endorses Judge Halpern’s views.
  • The Court then said that gift-giving was not a significant nontax purpose.

Observation: I must admit that he caught me by surprise as Bongard inferred otherwise.

  • The Court then raised additional concerns: The Partnership was mainly a collection of passive assets, primarily marketable securities and rental properties that remained in the same state as when they were contributed. The same investment advisers and property managers managed the assets both before and after the transfers to the Partnership. The Partnership made loans to family members. In at least one instance, even lowered an interest rate that a partner had previously agreed to pay. The Court concluded that the Partnership was a mere collection of mostly passive assets intended to assist decedent's tax planning and benefit the family.

    Observation: For all estate planners, this factor must be looked at. If you want to have a partnership, it must be operated as a business not as a depository of family assets run solely by the same family members.

  • The delay in funding the partnership. See Shepherd
  • The Estate was financially dependent on the FLP. The Court found that the sale of the house and the distributions would not have been entered into by the FLP but for the financial position of the estate.

    Observation: Did I say run it like a business! Just make sure that contemporaneous documents exist reflecting the business decisions are made. 

  • The decedent’s age at the time of the transfer reflected that the transfer was made to avoid estate tax.

    Conclusion: a Michael Jordan slam dunk for the IRS. But, at the same time an opinion worth analyzing and dissecting for purposes of planning and of course litigating.
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