In a case where a taxpayer transferred cash and securities to a limited partnership to remove them from her estate, the U.S. Tax Court concluded that as long as she retained her rights related to the assets until her death, their value was part of her estate. The Court further held that because her partnership interest was transferred, if at all, less than three years before her death, the value of the cash and securities transferred to the partnership was includible in the value of her gross estate to the extent required by the tax code.
An individual's gross estate includes property transferred during the person's life if he or she retained for life:
- The possession or enjoyment of the property, or the right to the income from the property, or
- The right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income from it.
These rules don't apply to a transfer that was a bona fide sale for an adequate and full consideration in money or money's worth.
In addition, an individual who transfers an interest in, or relinquishes a power over, any property, within three years of death, must include the value of the property in his or her gross estate to the extent it would have been included if the interest or relinquished power had been retained.
If property has been transferred for insufficient consideration, computing the amount that must be included in the estate requires subtracting the value of the consideration received from the value of the transferred property at death (or alternate valuation date).
Facts of the Case
On August 8, 2008, the son of the taxpayer made a transfer of cash and securities to a limited partnership, on his mother's behalf, in exchange for a 99% limited partner interest. The limited partnership had been formed two days earlier and the agreement gave the son, who was the general partner, sole discretion to determine the amount and timing of partnership distributions. That agreement also allowed for the partnership's dissolution with the written consent of all partners.
Also, on August 8, 2008, the son, purportedly acting under a power of attorney, transferred his mother's interest in the partnership to a charitable lead annuity trust (CLAT). The terms of that trust provided an annuity to a charitable organization for the rest of the taxpayer's life. Upon her death, the CLAT's "corpus" (the property transferred into it) was to be divided equally between the woman's two sons.
Following the taxpayer's death seven days later, the IRS, by separate notices of deficiency, determined a deficiency of $5.9 million in the estate's federal estate tax and a deficiency of nearly $3 million in the woman's federal gift tax for 2008.
The Tax Court concluded that the woman's ability to dissolve the partnership with the other partners was a right "to designate the persons who shall possess or enjoy" the cash and securities transferred to the partnership "or the income there from," within the meaning of the Internal Revenue Code. The court determined that if the woman retained until her death her rights with regard to the transferred cash and securities, the value of those assets would be included in the value of her gross estate. If, instead, she made a valid gift of her partnership interest before her death, and thus relinquished her retained rights, the value of the assets would still be included in the value of her gross estate.
The court also held that the full date-of-death value of the transferred assets didn't have to be included in the estate. Instead, only the excess of that value over the value of the limited partner interest that the woman received would be included.
If a transfer depletes a decedent's estate to any extent, the bona fide sale exception generally won't apply. But if the decedent receives some consideration, the tax code limits the required inclusion to the amount of that depletion. Because the estate didn't challenge the IRS's contention that the son who made the transfer on the woman's behalf had no legitimate and significant nontax reason for creating the partnership, the transfer wasn't "a bona fide sale for an adequate and full consideration in money or money's worth," regardless of the value of the limited partner interest issued in exchange for those assets. Therefore, the tax code limited the amount included in the gross estate.
A Question of Gift Tax
In addition, the court determined that the transfer of the assets to the CLAT was either void or revocable under applicable state law (California) because the woman's power of attorney didn't authorize her son to make gifts that exceeded the annual federal gift tax exclusion. If the gift was void, the value of the limited partner interest on the date of decedent's death would be included in the estate. If the gift was revocable, that same value would be included. Consequently, the value of the 99% limited partner interest as of the date of the woman's death, was included in the estate's value. (Estate of Nancy Powell, 2017, 148 TC No. 18)
LOUIS J. CERCONE, JR., CPA, CFE, CFF, ABV, ASA, CVA
Lou is the Managing Director of Brisbane Consulting Group in charge of business valuations, forensic accounting, and litigation support services. He has extensive valuation experience and has served as a financial consultant and expert to attorneys in the economic aspects of matrimonial dissolution. He has been engaged in several forensic accounting cases and has served the judiciary as a court appointed expert and receiver for financially troubled companies. He has testified as an expert witness in State Supreme Court and Federal Court. Lou has also been engaged in the quantification of lost income in determining business interruption claims for insurance adjusters.