• Tax Court Memorandum decision regarding valuation of family limited partnership (FLP) interests held in decedent’s revocable trust—In Estate of Frank D. Streightoff v. Commissioner, T.C. Memo. 2018-178, the Tax Court analyzed the character (and therefore value) of the interest in an FLP held by the decedent’s revocable trust.
In 2008, Frank formed an FLP under Texas law through his daughter, Elizabeth, under his durable power of attorney. Frank funded the partnership with equity securities, fixed-income municipal bonds and mutual funds. The general partner was a limited liability company, which Elizabeth owned and managed. Frank gave his daughters, sons and a former daughter-in-law limited partnership (LP) interests and retained an 88.99 percent LP interest.
On that same day that the FLP was established, Frank established a revocable trust, of which Elizabeth was the trustee and to which he assigned his LP interest. Elizabeth signed the assignment as Frank’s power of attorney, trustee of the revocable trust and managing member of the general partner. As trustee of the revocable trust, Elizabeth agreed to be bound by the LP agreement.
The partnership agreement provided that it would terminate in 2075, unless sooner terminated by the removal of the general partner, which could be effected by written agreement of limited partners owning 75 percent or more of the LP interests. Limited partners owning at least 75 percent of the LP interests could also approve the admission of additional limited partners. Transfers of LP interests were restricted to a class of “permitted transferees.” On transfer of an LP interest, an assignee could only become a limited partner if: (1) the general partner consented to the transfer, (2) the interest qualified as a permitted transfer, and (3) the transferee became a party to the partnership agreement and executed such documents as the general partner requested.
Frank died in 2011, and his estate filed a Form 706, which showed that the assets of the FLP were in excess of $8 million. The return valued the interest held by the revocable trust at $4.588 million, the value of which was discounted for lack of marketability, control and liquidity.
The Internal Revenue Service sent a notice of deficiency and asserted that the value of the interest in the FLP should be $5.993 million.
At issue was whether the assignment to the revocable trust resulted in it becoming a limited partner or holding only an assignee interest. The Tax Court held in favor of the IRS that the assignment made the revocable trust a limited partner. It relied on the terms of the assignment, which stated that the revocable trust was entitled to all rights associated with an LP interest and noted that it met the requirements of the partnership agreement for an assignee to be admitted as a limited partner: (1) Elizabeth, as managing member of the general partner, signed the assignment, giving consent to its terms, (2) the parties stipulated that the transfer was a permitted transfer, and (3) Elizabeth, as trustee of the revocable trust, signed the assignment and agreed to abide by the terms of the partnership agreement. In addition, the court noted that the substance of the transaction, in which Elizabeth was acting in all capacities and Frank retained the power to revoke the revocable trust, was the same either way: there was no real, practical difference between the transfer of an LP interest or assignee interest.
Having determined that the revocable trust held an LP interest, the Tax Court held that no lack of control discount was applicable. Interestingly, however, the court upheld a lack of marketability discount of 18 percent, without acknowledging that the interest held by the revocable trust could have terminated the FLP and withdrawn its interest.
• Private letter ruling on gift, generation-skipping transfer (GST) and estate tax effect of judicial reformation of trust—In PLR 201843005 (Oct. 26, 2018), the taxpayer established three separate trusts, one for each child and his respective issue. Each child was granted a special (non-general) power of appointment (POA) exercisable at death. The taxpayer created and funded the trust in reliance on an attorney, as part of the taxpayer’s plan to benefit his descendants of all generations and reduce transfer taxes. It was intended that the trust be GST tax exempt.
However, the trust wasn’t properly drafted. The children were granted withdrawal rights intended to qualify gifts for the annual exclusion. But, the withdrawal rights weren’t limited to the annual exclusion amount and lapsed in full annually. Furthermore, the taxpayer and his spouse didn’t affirmatively allocate GST tax exemption to the trust on a Form 709 (and given the problematic withdrawal rights, the GST automatic allocation rules wouldn’t apply).
The trustee of the trust filed a petition in state court to request judicial reformation of the erroneous provisions, which was approved. The taxpayer then sought a ruling regarding the estate and GST tax effects of the reformation. The IRS held for the taxpayer that: (1) the judicial reformation wasn’t an exercise or release by any child of a general POA, (2) the lapse of the withdrawal rights didn’t cause any child to be treated as making taxable gifts, (3) no part of the trust property would be includible in the children’s estates, and (4) the children didn’t possess general POAs over the trust except as provided under the corrected trust instrument. This was because the reformation was permitted under state law and was undertaken not to alter or modify the trust instrument but to correct a scrivener’s error.
Further, the IRS granted the taxpayer and his spouse an extension of time to file a supplemental Form 709 to allocate their GST tax exemption to the trust.