Home on the Middlefork of the Clearwater River
Until recently, the Northwest has suffered from drought conditions with even summer thunderstorms mostly absent. However, thankfully we recently have received good rains and so Fall is looking up, the leaves are turning and all is pretty green now.
Mary Ann and I spent a couple of weeks trailer camping and visiting family and friends. We traveled through Montana, Utah, Colorado, Wyoming and New Mexico, as well as Idaho. Experienced lots of beautiful scenery and enjoyed seeing bear, elk, moose, deer and antelope. But it is good to be home, especially this time of year.
Consulting and Education Activities
My consulting practice is going well and we are most appreciative of the support of friends, including former law clients, as well as my opportunities to work with professional advisors on tax and estate planning projects. I am available to be of help, as indicated in the Mission Statement and resume archived on the website.
On October 22nd, I will be a presenter at the October 22nd meeting of the Santa Clara County Estate Planning Council, of which I was a member for over 20 years. My subject, dealing with my personal tax case, will be “Tough Lessons Learned & Where I Go From Here – Remorse, Reconciliation and Recovery”. It will be a challenging and I hope worthwhile presentation. If any of my readers of this newsletter wish to attend – email me and I will send you the registration information.
Also, I am working out course proposals and scheduling for being a resort conference presenter for WesternCPE, which presents numerous courses, conferences and study opportunities for accountants. See the group’s informative website: www.westerncpe.com.
Interesting Item – Patents on Tax Planning?
There has been quite a controversy over whether so-called proprietary “tax planning patents” can or should be able to be obtained from the U.S. Patent Office. Several developments have occurred, including actions by the Treasury, by Congress, and by the U.S. Patent Office and one court. First, in late September, 2007, Treasury issued proposed regulations adding patented tax strategies to its list of “reportable transactions,” which itself should be enough to kill this idea. But the Service apparently prefers that Congress act – so on September 7th, the House passed the patent reform bill which includes a ban on tax strategy or planning patents. Now it will be the Senate’s turn. And on October 4th, Steve Leimberg provided us with the details on a recent Federal Circuit Court of Appeals case, In Re Stephen W. Comiskey, 2007 U.S. App. LEXIS 22414(9/20/07), which is adverse to the concept of patenting tax strategies. The Patent Office Examiner had concluded that 35 U.S.C. Sec. 103(a) applied – to wit: a patent cannot be issued where the invention “…would have been obvious at the time the invention was made to a person with ordinary skill in the art to which said subject matter pertains.” Mr. Comiskey sought to patent a method for mandatory arbitration concerning unilateral documents, as well as to patent a similar method respecting contracts, and on and on. See LISI author Dana G. Fitzsimons Jr., Esq.’s(Richmond, VA) article in LISI Estate Planning Email Newsletter – Archive Message #1184(10/04/07) for more details about the Federal Circuit’s upholding of the patent denial, stating in part: “…the application of human intelligence to the solution of practical problems is not in and of itself patentable.” No doubt there will be continuing controversy here!
And Finally, More on FLP/LLC Planning – Fiction vs. Reality
My June 14, 2007 newsletter included a review of Estate of Hilde Erickson, T. C. Memo. 2007-107(4/30/07), another “bad facts” case under IRC Sec. 2036(a)(1)(estate tax includability of inter-vivos transfers where transferor retains the right to income and/or enjoyment of the transferred property for his or her lifetime). This case opinion was published just over 10 years after the adverse 2036(a)(1) opinion in Schauerhamer, T.C. Memo. 1997-242, a case I tried in Tax Court as estate counsel.
Among the key factors I identified, from review of these and many other cases over the past decades, as being important to the success and reality of FLPs and LLCs were (i) timely funding of the entity, (ii) formalities being observed, (iii) pro-rata distributions to all partners, and (iv) the presence of substantial business or other non-tax purpose(s). Now two new court opinions have been issued, both using 2036(a)(1) to destroy the FLP and thus to cause gross estate inclusion of the assets transferred to the entity. These are summarized below.
1. Estate of Sylvia Gore v. Comm’r, T.C. Memo. 2007-169(6/27/07) – After a less than tax efficient plan for the previously deceased husband, the surviving wife and her advisors attempted to use the FLP to “create” substantial(55%) valuation discounts for gift and estate tax purposes – but 2036(a)(1) resulted in failure of the plan. The timing was short, the title transfers not completed prior to decedent’s death and Oklahoma law as well as both IRC Secs. 2036 and 2041(general power of appointment) were used by the Tax Court in creating a “box of alternative theories” from which the estate could not escape.
The court’s most telling statement in the Gore opinion is as follows: “The estate planning on behalf of both Sidney Gore and the decedent reflects a remarkable pattern of informality and inaction that makes any decision regarding what actually took place a difficult one.” So, no matter what legal arguments might be made(such as that 2036(a) cannot apply to a marital trust where the predeceased spouse is the deemed transferor), title transfers, exhibits to agreements and contemporaneous accounting records all matter. Once again a detailed review of Gore proves the necessity, if an FLP/LLC plan is to be treated as reality rather than fiction, that tax counsel and the accountant work closely together, and that the client(s) follow the plan in every respect. For my detailed discussion of this case, see the Leimberg LISI 7/2/07 Estate Planning Email Newsletter #1143.
2. Estate of Virginia Bigelow v. Comm’r, 9th Cir., No. 05-75957(9/14/07), affirming T.C. Memo. 2005-65 –
a. This case involves an elderly widow and a 7-year saga of estate planning involving her and her three children, with FLP formalities not followed, FLP distributions only to the decedent even though children and grandchildren were partners or income interest holders, the mother being “impoverished” by property contributions to the FLP, and generally there being no substantial non-tax purpose for the entity.
b. Tax Court Judge Colvin, in his 2005 memo opinion, found key facts upon which he based his 2036(a)(1) determination. After transferring her personal residence to a revocable trust in 1991, Virginia Bigelow(about 85 years of age) suffered a stroke and was moved to an assisted living facility. Then the revocable trust exchanged the home for investment real property in 1993, borrowing $350,000 secured by the new property to pay off prior loans and later on obtaining a bank loan of $100,000 secured by a second trust deed on the new property, the proceeds of which in part went to make gifts to Virginia’s children and grandchildren. Next, in 1994, Virginia’s revocable trust(son sole trustee) and nominally her three children(the latter $100 each) formed the FLP – the trust as sole 1% general partner and approximately a 96% limited interest for the contributed investment property; however the $450,000 in debt was held out of the FLP by the decedent.
c. This arrangement left Virginia(who had about to expire long term care benefits) “impoverished”, i.e. without sufficient funds to care for her living needs and expenses or to satisfy her personal obligations on the retained debt. Judge Colvin stated “Decedent’s sole purposes in establishing the family limited partnership were to facilitate gift giving and to reduce estate tax.”(Neither of these reasons qualify as business or non-tax reasons) The court’s findings of fact detail the gift program of the two types of partnership units as well as a transfer of income rights in certain units to grandchildren – all interesting, but to no avail as concluded by the court and affirmed by the 9th Circuit last month. At the date of decedent’s death in mid-1997(age 88) her revocable(then became irrevocable) trust owned the 1% general partnership interest and 45% in limited partnership interests. About a year later, the FLP plan was terminated, distributions made and the entity dissolved.
d. All these and other facts resulted in Judge Colvin’s opinion that (i) there was an “implied agreement” that decedent would(necessarily due to her impoverishment and support needs) retain the right to income and enjoyment from the transferred investment property until death, and that (ii) there was no basis in fact and law to apply the “bona fide sale for full and adequate consideration” exception to 2036(a)-based includability. Consequently, the gifts and the FLP were ignored for transfer tax purposes and the full value of the investment property was included in the decedent’s gross estate for estate tax purposes. The claimed valuation discounts were rejected, due to 2036(a)(1), not by reason of any valuation methodology arguments.
e. On appeal to the 9th Circuit, the 3-judge panel considered the case and Circuit Judge Ronald M. Gould writing the opinion, found no clear error on the part of the Tax Court and therefore affirmed its decision. The 9th Circuit opinion is must reading as this is the first 2036(a) opinion issued by the 9th Circuit in this recent era of estate tax litigation over FLP/LLC plans and claimed discounts for gift and estate tax purposes. Among important statements of the 9th Circuit opinion are the following:(1) “Section 2036(a)(1) is designed to recapture the value of certain assets transferred by the decedent during his or her lifetime where the decedent has retained economic benefits from the transferred assets.” (citing Kimbell, 371 F.3d at 261).
(2) “A key problem with the conveyance of the Padaro Lane(investment) property to Spindrift(the FLP) is, for estate tax purposes, that the (bank) debt that was secured by the property was not also transferred.” (parenthetical language inserted)
(3) “The Tax Court’s finding that partnership formalities were not observed buttresses the conclusion that there was an implied agreement.”
(4) Referring to the 40 distributions from the FLP all of which went to or for decedent’s benefit, the court pointed out “Moreover, no other partner benefited from such an informal and ad hoc access to partnership funds.f. On the “bona fide sale” exception argument of the estate, the 9th Circuit discussed a number of the cases considering the exception, and eventually fixed upon the rationale and analysis of Estate of Bongard v. Comm’r, 124 TC 95, at 118-119(2005) – must be an arms-length transaction(with family transactions receiving great scrutiny), and the taxpayer must “demonstrate that the transfer had ‘legitimate and significant non-tax reasons.’ “And so here too, the 9th Circuit found the Tax Court had not clearly erred in declining to apply the exception to 2036(a)
I hope my readers find this newsletter worthwhile, and I will continue to watch for tax and estate planning developments of interest and application to Family Wealth Planning.
Owen Fiore
