Stone v. Commissioner, T.C. Memo. 2012-48 (2012), is yet another confirmation that, when structured correctly, the taxpayer typically defeats the Internal Revenue Service in an Internal Revenue Code Section 2036 case.
To advance their family planning, Joanne Stone and her husband (the parties) formed the Stone Family Limited Partnership (SFLP) on Dec. 29, 1997. At formation, the parties were in good health. Originally, the parties owned all of the partnership interests in SFLP. The partnership agreement was revised two days after formation to reflect that 21 of the parties' children, children’s spouses and grandchildren (family members) received gifts of 0.634 percent limited partnership (LP) interests. Similar gifts were made again in 1998 and 1999. In 2000, 0.477 percent LP interests were gifted to each of the 19 remaining family members. By the end of 2000, the parties each owned 1 percent general partnership interests in SFLP, while their family members owned the remaining 98 percent LP interests.
All of the aforementioned gifts were on a pro-rata basis of the appraised value of the underlying real estate held by SFLP, as no discounts for lack of control and marketability were taken. In addition, SFLP earned no income, and its only expenses were property taxes, which were paid from the parties' personal funds. Finally, all of the owners of interests in SFLP made no use of the real estate held by SFLP.
At issue was whether the value of the assets transferred by the parties to SFLP should be included in the value of Joanne’s gross estate under IRC Section 2036 (a).
As further explained below, under the bona-fide sale test of Section 2036, the court rejected the IRS’ two primary arguments that SFLP didn't have a non-tax purpose.
1. Did the transfer of the parcels to SFLP qualify as a bona fide sale? The estate argued that the parties had two non-tax motives for transferring the parcels to SFLP: (1) create a family asset, which could be developed and sold by the family; and (2) protect the parcels from partition actions. The IRS argued that the parties only wanted to simplify the gift-giving process. While the court agreed with the IRS that gift giving alone isn't an acceptable non-tax motive, it disagreed that gift giving was the parties’ only motive in transferring the parcels to SFLP.
The IRS also contended that since the parties were on both sides of the transaction, the bona fide transfer exception wouldn't apply (Liljestrand v. Comm’r). However, the court noted that this situation is allowed if there's a legitimate non-tax purpose for the transaction (Bongard v. Comm’r).
The IRS also argued that the partners of SFLP failed to respect partnership formalities. However, other factors supported the estate’s argument that a bona fide sale occurred. First, the parties didn't depend on distributions from SFLP. Second, the parties transferred the parcels to SFLP. Third, there was no commingling of personal and partnership funds. Fourth, no discounting of the interests in SFLP for gift tax purposes occurred. Finally, the parties were in good health at the time the transfer of the parcels was made to SFLP.
After considering all of the facts presented, the court found that the parties had a legitimate and actual non-tax motive in transferring the parcels to SFLP.
2. Did the parties receive full and adequate consideration for the transfer of the parcels to SFLP? As the court had already found that the parties had a legitimate and actual non-tax purpose in transferring the parcels to SFLP, the court therefore found that the transaction wasn't an attempt to change the form in which the parties held the parcels and that the full and adequate consideration criterion was satisfied.
Has the IRS become a victim of its own prior success on Section 2036? Has the IRS seen so many victories in bad facts cases that they think the same analysis will save the day even when the facts are less bad? In Stone, there were minor lapses in adhering to partnership formalities, but the business purpose for the partnership was clearly documented and logical. The case is a validation of the family limited partnership as an estate planning technique.
1. In 1999 and 2000, two of Mrs. Stone’s children’s spouses didn't receive interests as a result of separate divorce settlements involving the transfer of property interests in the parcels held by the Stone Family Limited Partnership (SFLP), but not a transfer of actual SFLP interests.
2. Estate of Liljestrand v. Commissioner, T.C. Memo 2011-259 (2011).
3. Estate of Bongard v. Comm'r, 124 T.C. 95 at 121 (2005).
4. Because: (1) in divorce proceedings, the family members renounce all claim to their interests in the parcels to their former spouses but didn't transfer actual SFLP interests; (2) some inadequate documentation was kept for the partnership; and (3) the parties paid SFLP property taxes out of their personal funds.