• Tax Court rules on consequences of deathbed FLP transfer—In Estate of Nancy H. Powell v. Commissioner (148 T.C. 18 (May 18, 2017)), the Tax Court ruled on summary judgment motions relating to the estate tax consequences of certain deathbed transfers of decedent Nancy’s assets made by Nancy’s son, Jeffrey, under her durable power of attorney (POA).
On Aug. 6, 2008, Jeffrey formed NHP Enterprises LP, a Delaware family limited partnership (FLP). The opinion doesn’t say whether Jeffrey contributed assets to the FLP, but he was designated the general partner. Two days later, just over $10 million in cash and securities was transferred from Nancy’s revocable trust to the FLP in exchange for a 99 percent FLP interest. On the same day (Aug. 8), using a durable POA, Jeffrey transferred the 99 percent FLP interest to a charitable lead annuity trust (CLAT). Under the terms of the CLAT, an annuity was to be paid to the Nancy H. Powell Foundation, a Delaware nonprofit, for the remainder of Nancy’s life and, on her death, the assets to be split among her children. Nancy died one week later, on Aug. 15.
The estate filed a gift tax return for 2008, reporting the gifts relating to the CLAT, along with its estate tax return. The Internal Revenue Service issued a notice of deficiency disputing the value of the gift and the value of the partnership interest included in the estate.
The Tax Court held that the value of the cash and securities transferred to the FLP were includible in Nancy’s taxable estate under two alternative grounds. The first was based on the ability to dissolve the partnership and Internal Revenue Code Section 2036(a)(2). If Nancy had remained the owner of the 99 percent interest in the FLP on the date of her death, the court concluded that she had the ability to dissolve the FLP with the cooperation of her sons (the court didn’t go into detail regarding the revocable trust’s ownership of the interest versus Nancy individually and didn’t state explicitly whether Nancy was the sole trustee). The court held that this ability to dissolve the FLP was a right to designate the individuals who possess or enjoy the property, which would have caused inclusion of the cash/securities in her estate under IRC Section 2036(a)(2) had Nancy held it on the date of her death.
The estate argued that Nancy didn’t hold this power on the date of her death because the FLP interest had been transferred to the CLAT. However, transferring that 99 percent FLP interest days before her death didn’t change matters, because IRC Section 2035 applied. Section 2035 includes in the estate certain property: (1) transferred, or (2) subject to a power if that transfer is made or that power is relinquished within three years of date of death, if that property would have otherwise been includible in the decedent’s estate.
The second ground for inclusion was based on the right to direct partnership distributions. In its analysis, the court analogized to the foundational case, Strangi, and noted that even in the absence of the dissolution power, the assets should still be includible under Section 2036(a)(2) because Jeffrey was acting as Nancy’s agent under her POA and was, in his individual capacity, the general partner of the FLP. In effect, Nancy’s attorney-in-fact had the power to make distribution decisions, although in his individual capacity. Unlike the holding in the well-known case Byrum, which held that a decedent, as a majority shareholder, held fiduciary duties to minority shareholders that precluded inclusion under Section 2036(a)(2), the court in Powell found that any fiduciary duties allegedly held by Jeffrey were illusory because his duties were nearly exclusively to Nancy (or to her revocable trust) as the 99 percent limited partner.
The court then applied IRC Section 2043, in concert with Sections 2036 and 2035, to determine that the value includible in the estate was the excess of the value of the cash and securities over the value of the partnership interest. This, essentially, negated the benefit of any purported valuation discounts for lack of control and/or marketability. IRC Section 2043 (titled “Transfers for insufficient consideration”) provides that if a transfer is made for consideration but isn’t a bona fide sale for adequate and full consideration in money or money’s worth, and such property is included under Sections 2035 to 2038, only the excess of the fair market value at the time of death over the consideration paid is included in the gross estate. In this case, the estate didn’t challenge the IRS determination that the sale wasn’t bona fide so the court held that Section 2043 applied, and the value of the assets in excess of the value of the partnership interest was includible.
The court also found that Nancy’s gift of her FLP interest to the CLAT was void under California law (and therefore revocable under Section 2038(a)) because the POA didn’t give Jeffrey authority to make gifts, as required under state law. There was therefore no gift to the CLAT and no gift tax deficiency. However, because no gift occurred, Nancy was treated as owning the FLP interest on the date of her death, and it was includible in her estate.
All together, the end result is that the value of the cash and securities was still includible in Nancy’s estate, and there was no estate tax benefit to the transactions executed by Jeffrey.
The application of Section 2043 in this case is interesting because it’s so unusual. In prior cases, the factual scenario usually involved a decedent who continued to own an FLP interest until his date of death, and the IRS included the value of the assets held in the FLP in lieu of including the partnership interest under Section 2036. Several judges on the Tax Court acknowledged this and concurred in the result only. The concurring opinion held that the same result may be reached more simply by just applying Section 2036(a)(2) as the “string” that pulls the value of the assets transferred to the partnership back into the taxable estate. It argued that the application of Section 2043 simply wasn’t necessary.
• Center on Budget and Policy Priorities reports on estate tax facts—In light of the always-looming proposals to repeal the estate tax, especially under the Trump administration, the following facts may be of interest. According to a report published by the Center on Budget and Policy Priorities on May 5, 2017:
• Only about 0.2 percent of estates are federally taxable.
• While the top statutory federal estate tax rate is 40 percent, the average effective federal tax rate is about 17 percent, after taking into account the federal estate tax exemption and estate-planning techniques, such as valuation discounts.
• While the estate tax would generate less than 1 percent of federal revenue over the next decade, the Joint Committee on Taxation estimates that repealing the estate tax may cost $269 billion over the same time frame.