Happy Holidays and a Happy, Healthy New Year
Mary Ann and I enjoyed the Christmas holiday in Oregon with our daughter, Karen Ericson, and her family, as well as with son Mark and his friend Chelsea. Lake Oswego was beautiful, being a suburb of Portland, OR. Back at our riverfront home on the Clearwater River in Idaho, we have had rain, snow and some elk who sort of camp out in our front yard and the meadow behind the house.
Family and friends are especially important during the holidays, and we hope that my readers also have enjoyed their families at this time of year. It is great to look forward to the just commenced New Year, 2008, and to good health, good times and, in my case, continued consulting and education activities.
New Consulting and Education Opportunities
The consulting practice continues to expand, with several new opportunities having developed for early 2008. I have been assisting estate planners and tax practitioners in their efforts for integrated estate planning. Review of existing estate plans, FLPs and LLCs, as well as assistance to advisors preparing the Form 706(Estate Tax Return) has been a focus of my consulting recently. The 2007-released new Form 706 contains some pointed questions on the use of FLP/LLC plans and valuation discounts – so estates need to be careful in preparation of the 706, as well as in obtaining the best possible valuation appraisals.
On the education front, my 10/22/07 presentation to the Santa Clara Estate Planning Council went very well, and in early November I again was a presenter(as in the Fall of 2006) at the Coeur d’Alene Estate Planning Council – this time on the 9th Circuit’s opinion(9/14/07) case of Bigelow v. Comm’r. See my 10/15/07 newsletter for a report on this case. In early December, I was a presenter in new estate tax developments at the SourceMedia conference in Las Vegas titled “Tax Update & Technology Conference”. The nationally known Sid Kess, JD, CPA, was the conference chair, and I enjoyed this renewed opportunity for educating CPAs.
In 2008 I am scheduled for a number of “Resort Conferences” sponsored by Western CPE – see this education organization’s website at www.westerncpe.com.
My several courses will include a valuation discount and methodology course, a course on FLP/LLC planning and effective defense thereof, as well as an Estate and Gift Tax Update course. The courses will be presented(as you can see on the referenced website under Resort Conferences) in diverse places such as Napa Valley, CA, Las Vegas, NV, Jackson Hole, WY, Maui, HI, and also a 10-day Norwegian Cruise Lines cruise from New York to Quebec, Canada, and return to New York next October – during the Fall color season in New England. These conferences will provide me an excellent opportunity to present the topics assigned to me in a detailed fashion, supported by extensive outline materials.
Bigelow and now Rector – More Trouble for FLPs!
In my October 15th newsletter, I reported on the Estate of Bigelow v. Comm’r, 503 F.3d 955(9th Cir. 2007), i– the first 9th Circuit opinion involving IRC Section 2036(a), and affirming T.C. Memo. 2005-65. The Tax Court’s decision destroyed the FLP involved in Bigelow by application of Sec. 2036(a)(1), and denied use of the exception for a “bona fide sale for full and adequate consideration”. It did not take long for the Tax Court then to decide another case relying substantially on Bigelow.
In Rector v. Comm’r, T.C. Memo. 2007-367(issued 12/13/07), Tax Court Judge David Laro(who earlier had decided another FLP case in Rosen v. Comm’r, T.C. Memo. 2006-115) relied heavily on the 9th Circuit opinion in Bigelow as Rector was sited in California, which of course is within the 9th Circuit Court of Appeals jurisdiction.
In a footnote, fn. 7, to the Rector opinion, Judge Laro stated: We find on the basis of credible evidence at hand that decedent’s transfer of her assets to RLP and her ensuing gifts of the limited partner interests to her sons were part of a single plan to minimize decedent’s Federal estate tax, lacked a significant nontax business purposes, and accomplished no genuine pooling of assets.”
Perhaps advisors are becoming weary of 2036(a)(1) “implied understanding” cases that pile on facts and legal conclusions in the Tax Court’s efforts to find a testamentary plan intended to be thwarted by IRC Sec. 2036(a) of the Code, i.e. by ignoring the FLP or LLC entity as well as gifts of interests therein, and rather including in the decedent’s gross estate the assets transferred to the entity – at date of death, or, if elected, alternate valuation date, values. Of course, such a result makes irrelevant business valuation appraisals, including discounts opined therein, of transferred – whether during lifetime or at death –limited partnership interests or member interests in the FLP or LLC, respectively.
As is common in these cases, the decedent(Concetta H. Rector) and her two sons failed in a sufficient number of “critical fact” areas to allow – perhaps with little fear of reversal – the Tax Court to apply Sec. 2036(a)(1). In the opinion of the court, there existed no real and significant nontax or business purpose, and, of real concern for FLP/LLC planning, the court again fixed upon the absence of any “pooling of assets” – since Mrs. Rector directly and through her living trust was the only one contributing assets to the FLP. Other negative factors were the transfer of most of decedent’s accessible wealth to the FLP, failure to follow FLP formalities, and failure to follow a strictly pro rata distribution policy.
Perhaps the Tax Court really is applying in a broad way the “strict scrutiny principle” to family transactions – maybe very few families can “make the cut” if Judge Laro’s approach is adopted broadly by the court! The other issue here is the increased uncertainty and the costs of defending FLP/LLC plans – so taxpayers beware in the 9th Circuit. And of course, other circuits have considered FLPs as well – including, the 3rd and 5th Circuits.
A caveat is important here, especially given that I have tried several cases in Tax Court. That is, the court’s opinion is based upon the entire record in the case, and that is what the appellate court reviews, if an appeal is filed by either the Petitioner estate or the Respondent IRS. This record includes numerous documents not available without special effort by a person not the party to the litigation, including extensive stipulations of fact, pre-trial motions, the trial transcript, pre-trial memos of the parties filed with the court, etc. So generally commentators, such as myself, usually have only the court’s opinion upon which to rely for the case facts and the applicable law.
Judge David Laro is an experienced jurist with a strong estate planning professional background as well as years of experience in financial matters. He appears in Rector to be applying a strict and broad construction of 2036(a) with a somewhat practical bent in testing the estate tax reality of the FLP involved. And the facts, coupled with Judge Laro’s interpretation of the law, resulted in Rector being a taxpayer defeat.
The Rector Limited Partnership(“RLP”) was formed in 1998 by Mrs. Rector at age 92, while she still was active and exercising control of her assets, with over $8 million of cash and marketable securities, mostly the latter, consistent with the long-term investment holdings of the decedent and her late husband(who died in 1978. Only the decedent herself and her living trust contributed assets to RLP. She was in a convalescent home and her living expenses were not covered by the income paid from her deceased husband’s irrevocable trust established at his death in 1978 – note that the corpus of that trust was $2.5 million. Judge Laro refused to allow that corpus to be considered as realistically available to Mrs. Rector, and actually the trust terms stated that the trustees should look to Trust A(which held at the time only the limited partnership interests in RLP) for any shortfall in the decedent’s needs.
The court further dismissed as insufficient the estate’s contentions of “nontax or business purposes” for the FLP, namely, to allow for gifts to children and grandchildren(gifts are a testamentary-related purposes), to protect her assets from creditors(how is that possible when decedent was general partner!), and to significantly reduce the gross estate for Federal estate tax purposes(again a testamentary purpose).
Advisors, especially within the 9th Circuit’s area of jurisdiction, are encouraged to read carefully the Rector opinion. Much of the opinion appears to be based on “bad facts”, yet the message is clear – advisors and their clients should consider carefully the risk/reward ratio and issues in the use of FLPs and LLCs. This is not to say that such planning cannot be accomplished in a successful manner; rather great care must be taken to consider the messages from the Tax Court – whether we agree or disagree with the messages.
For a more detailed review of Rector v. Commissioner, see my published article in Steve Leimberg’s LISI Estate Planning Newsletter # 1220, posted on the internet on December 20, 2007.
I am looking forward to 2008, as is Mary Ann, and again I wish all my readers a Happy and Healthy New Year. I sincerely hope you find this newsletter to be worthwhile, and would appreciate receiving your comments.
Owen Fiore
