Mary Ann and I were in the Galapagos Islands and Peru most of March, but as seen below, valuation and entity related developments continued, and here in 2012 we are in the last year of the Tax Relief Act of 2010. So this newsletter summarizes some significant new developments of interest in family wealth planning, and then outlines my upcoming CPE efforts at conferences and on the internet via webcasting.
Estate Planning in 2012 - a Top Priority.
In a recent FORBES online article (Advisor Network), CPA/CFP Rob Clarfeld outlines "7 Major Errors in Estate Planning" noting the following errors frequently occur:
1 - Not having a Plan! - strange, but true, that many families with significant wealth and advisors on hand do not have any plan, or, perhaps worse yet, an existing plan is out-of-date.
2 - Using Online or DIY planning rather than competent professional advisors - once again the Internet is seductive, with several online estate planning enterprises begging for business! The intimate personal nature of Family Wealth Planning deserves direct and communicative relationships among clients and their advisors.
3 - Failure to review Beneficiary Designations and Titling of Assets - Generally, property laws of States determine property ownership and characteristics. In the 3 areas of Planning, People, Property and Process, a thorough analysis of the family's assets as to ownership, titling, and, where applicable, beneficiary designations, is critical to success in developing and implementing an estate plan.
4 - Failure to consider the Estate and Gift Tax Consequences of Life Insurance - life insurance being often a significant asset in the family wealth mix, certainly income, gift and estate tax consequences of that asset must be considered.
5 - Overlooking maximizing annual gifts - The $13,000 per donor, per donee, per year annual gift tax exclusions often is an important aspect of planning, especially in that its proper use does not reduce the lifetime gift tax exemption ($5 million for 2012 only!).
6 - Failure to take advantage of the $5 million unified gift and estate tax exemption in 2012 - Yes, here again we are on the brink of going back to 2001 transfer tax law, with a 55% estate tax rate and only a $1 million lifetime exemption! In this Presidential Election year, it is a rather safe bet there will be no new estate tax legislation, and no one can really predict what will happen in 2013. This should tell us new and updated flexible planning is important now, rather than clients merely waiting it out!
7 - Leaving assets outright to children - this issue, of course, depends on the children, or grandchildren, the nature and value of the assets, and many other factors. What author Clarfeld was getting at, of course, is the carefully documented use of entities separating management of assets from ownership. This can be accomplished by irrevocable trusts, pass-through entities such as FLPs, LLCs and S corporations, and by C corporations as well. The effective uses of entities, with the potential for substantial valuation discounts as well, is a key area of financial and wealth succession planning.
Some New Developments in the Courts.
"Turner II" - My October 4, 2011 Newsletter reported on the case of Estate of Clyde W. Turner, Sr. v. Comm'r, T.C. Memo. 2011-209, in which Tax Court Judge Marvel applied IRC Sec. 2036(a) so as to ignore the FLP entity, thus eliminating any valuation discounts on entity investment assets. This was another "bad facts" case. My March 4, 2012 Newsletter reported on a taxpayer estate victory in Estate of Joanne Stone v. Comm'r, T.C. Memo. 2012-48 - involving a "family legacy" asset of undeveloped woodlands. Here the FLP was upheld for estate tax purposes, and thus valuation discounts allowed. "Turner II", 138 T.C. No. 14 (March 29, 2012), was the result of the estate's filed motion for reconsideration, based on its claim that the increased gross estate of decedent should qualify for a marital deduction. However, Judge Marvel held that the estate cannot receive a marital deduction respecting FLP interests or assets attributable thereto that decedent transferred by way of gifts during his lifetime.
Estate of Beatrice Kelly v. Commissioner, T.C. Memo. 2012-73 (March 19, 2012) is a significant taxpayer victory on the 2036(a) issue which has been the main attack vehicle against FLP/LLC use by families thereby seeking valuation discounts on lifetime transfers of FLP/LLC equity interests. Decedent was incapacitated, a widow, and had four (4) children, one of which (Roy) suffered from Down syndrome and could not care for himself. The other three (3) children, Bill, Betty and Claudia (the "children" in the court's opinion) worked actively in the family's Georgia quarry business and assisted their mother, eventually become co-guardians of Roy and later co-guardians of their mother, Beatrice.
The three children entered into a settlement agreement regarding the handling of their mother's estate, but an estate planning attorney advised that using four (4) FLPs and a corporation as general partner of the FLPs would better accomplish the family goals of preservation of family assets from liability (the quarries raised liability problems). The Georgia court approved the partnership plan, including recognizing that there could be nearly $3 million in estate tax savings as the result thereof.
The management corporation (KWC) was run by the three children, with decedent owning all its stock. Several FLPs were formed with various real property holdings funding each of them and the quarries were contributed to a fourth FLP, Kel-Tex, LP - KWC was the general partner, and decedent was the 99% limited partner of each of the partnerships. A management fee was paid to KWC by each partnership. Marketable securities also were contributed by decedent equal to the FLPs. Then on 12/31/03, 1/1/04 and 1/1/05 partnership interest gifts were given the three children and their descendants. The case record was clear that the children made a good effort to determine a reasonable management fee for KWC's management of the FLPs. Since each of the three children provided services to KWC, they each received compensation from the management corporation.
Decedent died, a resident of Georgia, March 17, 2005. At that time, she owned no interest in one FLP, 33.9% limited partnership interest in another FLP, 35.3% limited interest in another FLP, 99% limited interest in the quarry FLP, and all the shares of KWC, the management corporation. On audit of the 706 filed in decedent's estate, IRS proposed an estate tax deficiency of $2.2 million, taking the position per IRC Sec. 2036(a) that the value of all the assets contributed to the FLPs was includable in decedent's gross estate.
Tax Court Judge Foley (the judge in my 1997 Schauerhamer case applying 2036(a) in a "bad facts" case, see T.C. Memo. 1997-242) went through in detail all the transfers, i.e. first asset transfers to the FLPs, and then the partnership interest gift transfers. First of all, in the creation and funding of the FLPs, with all the significant non-tax reasons supporting the entities, Judge Foley determined that the "bona fide sale" exception to application of 2036(a) applied. The court stated, "...decedent's primary concern was to ensure the equal distribution of decedent's estate thereby avoiding litigation." Many of the assets required active management, and the court concluded this "...would lead any prudent person to manage those assets in the form of an entity." Further, the court found that there was no evidence that tax savings motivated decedent (or her children).
Next, the court considered the gifts of FLP interests, and evaluated the facts under Sec. 2036(a)(1) since the "bona fide sale" exception could not apply to gifts. The court rejected the IRS argument that there was an implied agreement for decedent to continue to enjoy income from the FLPs. In addition, the management fee arrangement involving the corporation general partner, KWC, was determined not to be an express retention of income by decedent. Decedent, via her guardianship account, had substantial assets to take care of her personal support needs. Therefore, decedent, as stated in the court's opinion, "...did not retain an interest in the transferred FLP interests." The result was here the gifts were not brought back into the gross estate.
Joanne Wandry v. Commissioner, T.C. Memo. 2012-88 is another in the line of cases supporting for gift and estate tax purposes "fixed dollar defined value" clauses against IRS public policy attacks. Here a well-drafted formula clause fixed the gift values for the transfers, even though there was no inclusion (as in prior taxpayer victories) of a contingent transfer to a charitable beneficiary of any asserted excess value of transfers. In Steve Leimberg's LISI Estate Planning Email Newsletter (www.leimbergservices.com), Archive Message #1941 (3/27/12), commentator Paul Hood provides an excellent review and insight into the defined value formula transfer planning area. As Paul states, "properly designed and implemented defined value transfers are more legitimate now than ever before and should be accorded respect for tax purposes..." This opinion is a "good read" on the current state of defined value transfers, and perhaps IRS will finally get the message!
Estate of Lois L. Lockett v. Comm'r, T.C. Memo. 2012-143 (April 25, 2012), does not involve IRC Sec. 2036(a), but nevertheless a FLP was ignored - this time because before her death, decedent had beome the owner of all partnership interests and thus, per the partnership agreement and Florida law, the entity was dissolved! Here Mariposa FLP received substantial assets from Lois Lockett, which then were used, in conduit form, for various purported "loan transactions" with her heirs. Tax Court Judge Haines provided a good discussion of what is needed to respected transfers as loans rather than gifts, as asserted by the Service. In fact, most of the "loans" were deemed such, even with spotty payment of interest and principal by the payors. The claimed 40% combined valuation discount for decedent's FLP interests at death was totally lost by the estate due to the dissolution as a matter of law and agreement of the FLP when decedent became "sole partner". An irrevocable trust (Trust "A") established at the death of decedent's husband for some unknown reason was liquidated (it was a general power of appointment trust allowing for decedent's termination of the trust at any time). Trust A and decedent through her revocable living trust were the only partners; therefore, at Trust A termination, decedent received partnership interests and became the 100% owner of the entity - so the entity self-destructed! Probably various changes in advisors along the way did not help the situation. LISI is publishing my detailed commentary on the Lockett case opinion.
These cases are several among many developments affecting Family Wealth Planning. My future Newsletters will continue to focus on valuation, entity planning and tax legislation developments and possibilities.
CPE Opportunities - Owen Fiore Presentations.
First of all, I am presenting two (2) "family succession planning" courses at resort conferences sponsored by Western CPE (www.westerncpe.com). These conferences and the details on the courses can be seen on the Western CPE website - June, Sunriver, OR, September, Whitefish, MT (near Glacier Nat'l Park), and October, Scottsdale, AZ. Then November 12-16, 2012, at San Antonio, TX, I will be chairing and speaking at the Western CPE Theme Conference - "Family Wealth Succession Planning" - an excellent opportunity for CPAs and other tax professionals to learn the ins and outs of succession planning.
In the webcasting area, I am a presenter of four (4) separate, succession planning related, courses for two web CPE providers, namely, CPELink (www.cpelink.com) and CPECredit (www.cpecredit.com). The courses review Valuation planning, Family Wealth Planning, Pass-Through Entity Planning, and Buy-Sell and Deferred Compensation Agreement Planning. These webcasts begin May 31st and continue on into December, 2012.
Finally, some tax professionals may subscribe to the CCH Business Valuation Update bi-monthly publication, for which I am a contributor from time to time.
In you have any questions on these CPE opportunities, send me an email to owen@owenfiore.com.
I hope you enjoy this May 2012 Newsletter!
Owen Fiore - On the Wild & Scenic Middle Fork of Idaho's Clearwater River!
