Estate of Sarah D. Holliday

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By, Kevin M. Ellis, Esq. of Hemenway & Barnes LLP

Citation: TC Memo 2016-51

Overview:  The Tax Court held that the value of investment assets transferred to a family limited partnership (“FLP”) by decedent must be included in the decedent’s estate without discount.  The Tax Court determined that there were no legitimate and nontax reasons for transferring assets to the FLP, and that there was an implied agreement that the decedent retain the possession or enjoyment of, or the right to use the income from, the transferred property.

Summary of Facts:  Decedent (through her son, who held her power of attorney), created a limited partnership in which she was the 99.9% limited partner, and her wholly-owned LLC was the 0.1% general partner. Approximately a week after creating the entities, decedent contributed nearly $6 million of marketable securities to the partnership.  On that same day, she sold her entire membership interest in the LLC to her two sons, and gave 10% of her interests in the limited partnership to an irrevocable trust that she created.

Following all of the transfers, decedent owned 89.9% of the limited partnership, and also retained significant assets outside of the partnership.

The limited partnership agreement stated that one of its purposes was to provide “a means for members of the Holliday family to acquire interests in the Partnership business and property, and to ensure that the Partnership’s business and property was continued by and closely-held by members of the Holliday family.” Limited partners did not have a right to participate in the partnership’s business or operations, but the agreement did provide for distributions to limited partners to “the extent that the General Partner determine[d] that the Partnership ha[d] sufficient funds in excess of its current operating needs to make distributions.”

The partnership made one small ($35,000) pro rata distribution.

Decedent died two years after the creation of the FLP, and her estate claimed a 40% discount for her remaining 89.9% limited partnership interests.

Tax Court Analysis: The IRS argued that the transfer of assets to the partnership triggered §2036(a)(1), requiring that the partnership assets be included in decedent’s estate without a discount.

Inclusion under §2036(a)(1) requires that (i) the decedent made an inter vivos transfer of property, (ii) the decedent retained (either explicitly or by implied agreement) the possession or enjoyment of, or the right the income from the property, and (iii) the transfer was not a bona fide sale for adequate and full consideration.

Focusing on the second requirement of §2036(a)(1), the Tax Court found that decedent retained, by implied agreement, the enjoyment of the property. The Tax Court focused on language in the partnership agreement requiring the distribution of “distributable cash” (cash in excess of operating needs) on a periodic basis. The Tax Court also determined that that the decedent was entitled to distributions in certain circumstances, and that operationally, according to testimony of decedent’s son, if decedent needed a distribution, one would have been made to her.

Further, focusing on the third requirement of for inclusion under §2036(a)(1) – that the transfer was not a bona fide sale for adequate and full consideration – the Tax Court rejected the nontax arguments for the creation of the limited partnership. Specifically, the Tax Court rejected the following as legitimate and significant reasons for creating the partnership:

  1. Protection from litigators’ claims: The Tax Court noted that decedent had never been sued before, was not at high risk from “trial attorney extortion,” and in fact held other substantial assets that could be reached by any attempted extortion.
  2. Protection of assets from “undue influence of caregivers”: The Tax Court focused on the fact that decedent’s property was managed by her sons as evidence of her reduced susceptibility to this concern, and also cited a lack of evidence of any concern about this issue in forming the partnership.
  3. Preservation of assets for the decedent’s heirs: The Tax Court noted that the decedent was not involved in creating the entities, but that her sons did so as her power of attorney, and that other family assets were managed well without need for this structure.

The Tax Court made other determinations that undermined evidence of a bona fide transaction. The Tax Court found that this was not an arms-length transaction because no real negotiation or bargaining occurred. Further, the limited partnership did not maintain adequate books and records or follow other formalities that supported its operating as a meaningful stand-alone entity. Finally, the Tax Court noted that there was no active management of the assets, but rather only passive trading, which supported an argument that the transfers occurred only to obtain a valuation discount.