• Tax Court holds family limited partnership (FLP) assets includible in estate—In Estate of Howard v. Moore, T.C. Memo. 2020-40 (April 7, 2020), the Tax Court held for the Internal Revenue Service and disregarded the structure of an FLP to include the date-of-death value of the FLP assets in the decedent’s estate for estate tax purposes.
Howard Moore had run a farm all his life, and at age 88, in 2004, he decided to sell the farm. He started to negotiate its sale with a neighboring family farm company in September 2004, but just a few months later in December, Howard was rushed to the hospital with congestive heart failure and a heart attack. Although in critical condition and then under hospice care, he stubbornly continued to manage the farm.
In December, while trying to recover from his health problems, he consulted an estate planner. Ultimately, he established various trusts and an FLP. The FLP was set up on Dec. 20, 2004, the partners of which were a Management Trust (1% general partner, owned by Howard), Howard’s Living Trust (95% limited partner) and his four children (1% limited partner each).
In February 2005, within five days of having contributed the family farm to his Living Trust and FLP, the farm was under contract to be sold to the neighboring family’s company. There had never been any meeting of the FLP partners. Howard continued to live on the property after the FLP was established and after the sale of the property (which the court acknowledged was common practice with a sale of a long-held family farm).
Howard died in March 2005. His estate filed the estate tax return and on review, the IRS issued a notice of deficiency in an amount of almost $6.4 million, asserting that the FLP assets, rather than the FLP interest, were includible in his taxable estate.
The court agreed and held that the transfer of the farm to the FLP wasn’t a bona fide sale for adequate and full consideration because there was no genuine non-tax purpose: Howard knew that the farm would be sold before it was transferred to the FLP. The estate had argued that the FLP provided creditor protection, but the court wasn’t convinced. It also noted the “testamentary essence of the whole plan,” which involved no bargaining and no negotiating, as Howard unilaterally set up the FLP.
Furthermore, Howard retained possession and enjoyment of the farm property as he continued to reside there and continued to control the farm assets even though he wasn’t personally the general partner. Because his relationship to the assets remained unchanged before and after the transfer to the FLP, the assets were included in his estate under Internal Revenue Code Section 2036(a)(1).
The opinion then goes on to analyze several other issues, including the application of IRC Section 2043 to determine the value of the includible property and whether certain transfers to his children were properly characterized as gifts or loans.
• Ninth Circuit rules on inclusion of grantor-retained annuity trust (GRAT)—In Badgley v. United States (No. 18-16093 (April 28, 2020)), the U.S. Court of Appeals for the Ninth Circuit affirmed that the assets of a GRAT were includible in the estate of the decedent who died before the end of the GRAT term.
Patricia Yoder funded a 15-year GRAT with a 50% partnership interest in a family-run company. Patricia died before the GRAT term ended. The executor of her estate initially filed its estate tax return including the value of the GRAT’s assets. However, later, the estate filed a tax refund action arguing that only the net present value of the unpaid remaining annuity payments should have been included.
The Ninth Circuit affirmed the lower court’s grant of summary judgment for the IRS. It held (unsurprisingly) that the GRAT assets were includible in the estate under the principles of Section 2036, even though annuities aren’t specifically mentioned in the statute. The grantor derived substantial economic benefit from the GRAT property in the form of the annuity payments; therefore, she retained enjoyment of the property under Section 2036(a)(1). Whether the annuity payments were from income or principal was irrelevant. The critical factor was that the GRAT corpus generated a benefit, the rights to which Patricia retained.
Patricia’s estate also challenged the formula the IRS used to calculate the portion of the property includible in the estate. However, the argument was raised in such a cursory manner that the court didn’t entertain it. But, it noted that even if the argument hadn’t been waived, it wouldn’t have been upheld because the estate didn’t argue that the formula didn’t apply to Patricia’s particular annuity. Its general argument that the formula was arbitrary as applied to a short-term GRAT wasn’t relevant to the case at hand.
• Spouse doesn’t owe gift tax from settlement agreement—In Private Letter Ruling 2020160002 (April 17, 2020), the IRS confirmed the tax treatment of a surviving spouse’s settlement agreement with her family that resulted in the termination of two marital trusts. Her husband had established two qualified terminable interest property (QTIP) trusts for her benefit, one as part of his revocable trust and one as a separate irrevocable trust. She became estranged from her husband and lived apart from him. After he died, she filed a petition in the local probate court to set aside his estate plan. After substantial litigation, she entered into a settlement agreement with the estate, the goals of which were to terminate the trusts and provide for her and the remainder beneficiary, a charitable trust.
In the settlement agreement, the spouse was to receive a payment of principal from each trust in consideration of her costs and then an additional cash payment equal to the value of her lifetime income interest, calculated using the IRC Section 7520 rates. The remainder of both trusts was payable to the charitable trust.
The IRS confirmed that the principal distribution to her wasn’t a disposition of her interest under IRC Section 2519 because the trustee had the authority to make discretionary distributions of principal to her. Although the payments of the equivalent value of her lifetime income interest were dispositions under Section 2519, there was no gift of the income interest because she received the full value in exchange as consideration. In addition, because the remainder was payable to a charity, any deemed gifts by her under
Section 2519 would be eligible for the marital deduction.
The surviving spouse had also disclaimed any contingent remainder interest in the trust. The IRS confirmed that the disclaimer was part of an arms-length transaction in which she received adequate consideration and so it didn’t result in a gift. Lastly, even though the charitable trust was a private foundation subject to self-dealing rules, those rules didn’t apply to transactions between it and the spouse (as a disqualified person) with respect to this transaction because it was the transaction that gave rise to her status as a disqualified person.