May Seminars Coming Up
My
May seminars for Western CPE(see www.westerncpe.com) are just around
the corner - Napa, May 9th and 10th, Las Vegas, May 23rd, and Jackson
Hole, WY, May 20th and 30th. My March 9, 2008 Newsletter has all the
information on these courses, one being on Estate and Gift Tax
Valuation Planning and the other involving Strategic Planning Using
FLPs, LLCs and S Corporations. Check out the Western CPE website for
the details!
Estate Planning More Important Than Ever
With the 2008 political uncertainty about the national elections, the current economic downturn, and continuing uncertainty about the future of the Federal Estate Tax, more than ever families and their advisors need to focus on a review of current planning, improvement of plans for wealth preservation and succession, and a commitment to the steps necessary to design, document and implement an effective Family Wealth Plan.
In my experience, the concept of "Fair Market Value" is at the core of Family Wealth Planning with entities and techniques combined in the best possible way. Therefore, a team concept is essential, which must include qualified appraisal advice as well as the traditional planners such as lawyers, accountants and life insurance advisors. Of course, I am available as a consultant to families and their advisors.
In a recent Tax Management publication, T.M.'s Estates, Gifts and Trusts Journal(2008),
there was an excellent article, co-authored by two Michigan attorneys,
Julius H. Giarmarco and Sebastian V. Grassi, Jr. This is a most
worthwhile article for reading by both advisors and their clients. It
is entitled "The Ten Levels of Estate Planning", and is
set up in terms of specific action plans. After the obvious discussion
of the importance of a married couple fully using their respective
applicable exclusion amounts(now $2 million for estate tax purposes),
the ten item "to do" list goes on into gifts without paying gift tax or
using up the $1 million gift tax exemption amount, leveraging gifts
through life insurance trusts, reducing or shifting value of
assets(especially appreciating assets), using Chapter 14's 2702 trusts,
etc.
I am using a summary of this article, together with my own
additions thereto, for my Western CPE courses. If any reader of this
Newsletter wishes a copy of this 7-page memo, just email me with your
request and I am happy to email a copy back pronto.
My March 9th Newsletter identified several topics for future newsletters, and I will get back to these soon. However, below I provide a summary and discussion of a most exciting case that recently came down from the Tax Court, namely, the Mirowski case - a breath of welcome fresh air in the FLP/LLC planning area.
Estate of Anna Morowski, T.C. Memo. 2008-74(March 26, 2008)
In some of my recent Newsletters, I have reported on significant taxpayer defeats in the FLP/LLC area involving such entities being disregarded entirely for estate tax purposes. Such cases included Estate of Bigelow v. Comm'r, 9th Cir. No. 05-75957, affirming the Tax Court, 9/14/07, and Estate of Rector v. Comm'r, T.C. Memo. 2007-367, 12/13/07. True, there were "bad facts" in these cases; however, these decisions provide encouragement to IRS ongoing attacks on pass-through entities, even though in many situations they should and have been respected for transfer tax purposes.
So now in Morowski, we have a total taxpayer victory, even on valuation discounts! The Service tried to destroy the LLC involved using IRC Secs. 2036, 2038 and even 2035, but to no avail due to the very strong non-tax purposes for the entity and a judge, Judge Chiechi, who believed the estate's witnesses and was most impressed with the history of the Morowski Family, as we will see below. Here is a case where the LLC was formed and received from the decedent mother, Anna Morowski, just a few days before her unexpected death many millions of dollars in value, including patent rights and licensing agreements producing significant annual royalties and mardetable securities. In addition, just 3 days before death, Anna successfully gifted substantial LLC member interests to irrevocable trusts for her three daughters.
So let us look at the 85 page Tax Court Memo Opinion authored by Judge Chiechi and learn of her extensive Findings of Fact and her Opinion in this remarkable case. I have authored a couple of articles already on Morowski, one for Steve Leimberg's great LISI series of Email Newsletters(see www.LeimbergServices.com - Estate Planning Email Newsletter #1268, 3/31/08) and an article soon to be published in BV Update, the Business Valuation Resources monthly publication for professional appraisers and other advisors.
1. Overview of Facts.
Of particular importance and typical of the strong language favoring the taxpayer in this opinion was the statement of Judge Chiechi at page 50, footnote 44: "On the record before us, we find that Ms. Morowski's significant and legitimate nontax purpose in forming and funding MFV(Morowski Family Ventures, LLC) of insuring joint management of the family's assets by her daughters(all 3of which were co-trustees of each daughter's truss) and eventually her grandchildren, standing alone, is sufficient to satisfy the requirement that, in order to qualify for the exception in Sec. 2036(a) for a bona fide sale for an adequate and full consideration in money or money's worth, there must be a legitimate and significant nontax reason for creating the entity in question." This brings to mind another "great facts" case, namely, Estates of Stone v. Commissioner, T.C. Memo. 2003-309, which likewise was a taxpayer victory on the facts.
Decedent and her husband, who died in 1990, had a long history of having and encouraging a close knit family, taking annual family vacations with the three (3) daughters and later their children and families, and at such times discussing family business and investment issues often with lawyers and accountants as guests at the meetings. As stated in Forbes, May 5, 2008(Informer feature), Dr. M. Mirowski was the principal developed of the initially scorned but now popular implantable cardioverter defibrillator - which became, especially after his death, the principal source of the Mirowski Family's wealth. As Forbes writer Janet Novack stated(I was one of her confirming sources for the article) in the headline: "More History Made". Truly here was an LLC formed just prior to death of the decedent, gifts also being made just before death, and the parties' stipulated valuation discounts were successful both for gift and estate tax purposes - due to teh Tax Court's upholding of the validity of the LLC!
Dr. Morowski spent many years developing the heart implant device and also many years obtaining financing for such development and eventually marketing through licensing agreements. He owned a 73% interest in the patents involved. Following his death in 1990, at which time his ICD patents and licensing agreement shares went to his wife, Anna, there was a long history of family and charitable gifts by Anna and it was important to her that the family remained close in every way. Anna created and funded with interests in the ICD and its rolalties an irrevocable trust for each daughter in 1992, and named all 3 daughters as co-trustees. The royalties increased dramatically and eventually amounted by the time of Anna's death to millions of dollars per year. By the formation of the LLC(MFV), Anna still owned 51.09% ot the ICD patents and licensing agreements.
In the year 2000, the idea of an LLC for the family investments was presented by U.S. Trust, and Anna's long-time attorney prepared draft articles of organization, operating agreement, etc. However, as family decisions usually were made at the annual family vacation/meeting, nearly a year went by until the August, 2001 meeting took place at which the family decision was made - form and fund the LLC, with the understanding Anna was going to make significant gifts of LLC interests to the daughters' trusts. At this point the recurring foot ulcer problem for Anna, a diabetic, became more of a problem.
The timing of formation, funding, gifting as to the LLC and its interests was rapid, closely-timed and barely completed before Anna's death: August 14 - family meeting and decision to go with the LLC plan, August 22-final LLC documents sent Anna for signature, August 27-LLC documents executed, August 30-appropriate State of Maryland filing of MFV Articles of Organization, September 1-7-transfers of assets of Anna, sole member of the LLC, to MFV(all her interest in ICD patents and royalty agreements, securities valued at over $60 million and cash of $1.5 million - quite a push for action! Then also on September 7th, Anna made gifts to the daughters' trusts of 16% member interests to each one, a total of 48% in member interests. Anna, the sole managing member of the LLC, took a sudden turn for the worse in her treatment of the foot ulcer on September 10th, and died on 9/11/01 - the day of the infamous terrorist attacks on the U.S.! The facts were absolutely clear and the testimony unshakable that Anna was not expected to die from her condition until the sudden change in circumstances on September 10th, only 3 days after these gifts.
These facts, set forth in great detail in the Tax Court's Findings of Fact, including a number of telling footnotes, set the stage for Judge Chiechi's analysis, followed by her conclusions fully supporting the Mirowski Family's position before the court. Here we clearly had "great facts", "excellent lawyering", and a "thoughtful judge" who was well aware the the hurdles of supporting an LLC formed just prior to a person's death.
2. Valuation Conclusions and Court's Opinions
a. Valuation Discounts.
In this case we had both gifts(3 days prior to death) and a 52% interest of decedent in MFV at date of death to be valued. Since the Petitioner, Estate of Morowski, and the Commissioner of Internal Revenue(Respondent) were focusing most on the issue of whether the LLC should be respected for gift and estate tax purposes, the parties stipulated the valuation discounts from asset values as agreed. According to Curt Kimball, of Willamette Management Associates(who was the expert prepared to testify on valuation at trial), the taxpayer and IRS appraisers were fairly close on their valuation conclusions. Ultimately, in the stipulated values there were used the following approximate combined discounts - (1) over 40% for the gifted interests, and over 20% for the 52% interest of the decedent at death. That amounted to many millions of dollars of transfer tax savings once the court determined that MFV must be respected for gift and estate tax purposes.
b. Judge Chiechi's Opinion.
Now as to the legal issues, based on factual analysis and findings per the court, Judge Chiechi knocked down strongly each and every argument made by Respondent IRS. The details of the 2036, 2038 and 2035 arguments, and their rejection by the Tax Court, are contained in my cited detailed articles and, of course, in a number of other articles on this case.
Essentially, as to the transfers of assets to the LLC, and whether the "bona fide sale" exception to Secs. 2036(a) and 2038(a) applied, the Judge found that the strong and legitimate nontax purposes of the LLC and the care in forming and funding the LLC were sufficient to support this particular entity. As to the gifts, a careful analysis of IRC Secs. 2036(a)(1) and 2036(a)(2) found on the facts that there was no prohibited retention of income, economic enjoyment, etc. from the gifted interests. And, finally, given that the court concluded that 2036(a) and 2038(a) did not apply here, the closeness in time of the gifts to Anna's death was not a factor - i.e. the prohibited 3-year rule of 2035 only applies to life insurance and to gifts that are subject to 2036, 2038, etc.
Interestingly enough, the Respondent's citing of all its judicial victories against FLP/LLC plans merely was dismissed by Judge Chiechi as involving cases distinguishable from Morowski on their respective facts.
However, are we "out of the woods" now on FLP/LLC plans - No Way! To develop facts such as involved in cases like Stone and Morowski takes work, and often just cannot be done. It is possible, of course, the Service may appeal the Tax Court's decision here. In any event, the importance of a total, realistic, and legitimate planning effort, insuring that there are true and significant nontax purposes for an entity, cannot be stressed too much. Planners will be discussing this case with their clients for many months to come. As Janet Novack said - More History Has Been Made!
I hope you have enjoyed this Newsletter, and I welcome comments and suggestions from readers.
Owen G. Fiore
FioreWealthPlanningConsulting
Kooskia, ID
www.owenfiore.com
