Tax Court Clarifies Inclusion of FLP Assets in Estate Tax Calculations

In Tax Court Memorandum Decision 2024-90, the court reinforced its stance on the inclusion of assets transferred to a Family Limited Partnership (FLP) in a decedent’s estate under certain conditions. In line with the rulings in Strangi and Powell, the tax court determined that the decedent maintained significant control over the assets moved to an FLP, requiring their full date of death value to be included in the estate. This case serves as a critical reminder to carefully evaluate the structure and intent of similar transfers.

Background

Anne Milner Fields inherited an oil business from her husband upon his death in the 1960s and became a successful businessperson. With no children of her own, she mentored her great nephew, Bryan Milner, designating him as her successor and granting him a durable power of attorney to manage her assets.

Before Anne’s death, Bryan executed a limited partnership agreement for AM Fields (the FLP) under the power of attorney granted to him. He also created a single member LLC, AM Fields Management, as the sole member and manager. AM Fields Management was named the general partner of the FLP, and Anne was named the sole limited partner. The partnership agreement gave the general partner sole and exclusive right to manage the business of the FLP. The agreement outlined:

• Profits for each fiscal year were allocated to the partners in proportion to their respective percentage interests.
• The general partner had absolute discretion to distribute cash to the partners in proportion to their respective percentage interests.
• The partnership would dissolve and wind up upon the affirmative vote of all the partners and that in the event the partnership was wound up, partnership property would be liquidated and the proceeds, after payment of partnership debt and liabilities, distributed to the partners in accordance with their respective capital accounts.

Bryan signed the partnership agreement in his role as manager of the LLC and on Anne’s behalf as her agent. The LLC contributed $1,000 in exchange for a .0069% interest, and Anne contributed $16,972,409 for a 99.9941% limited partnership interest. After completing the transfers to the FLP, Anne had approximately $2.15 million of assets remaining. She passed away nineteen days after the execution of the partnership agreement and seven days after she made her final transfer of assets to the FLP.

On Form 706, the estate included Anne’s limited partnership interest in the FLP with a value of $10,877,000. Anne’s will provided for specific bequests to family members and charitable bequests totaling $1.45 million. The estate reported a tax liability of more than $4.61 million. Not having enough cash to pay the estate tax, Bryan sold some of the FLP’s assets and distributed the cash to the estate to pay the liability.

The IRS issued a Notice of Deficiency, claiming that IRC Section 2036 applied, and the full date of death value of the assets contributed by Anne should be included in her gross estate. The service also assessed a 20% accuracy related penalty under IRC Section 6662(a) and (b)(1) due to negligence or disregard of rules or regulations.

The Court’s Ruling

The court had to determine whether Anne retained possession, enjoyment or the right to the income from the property she transferred to the FLP. Relying on the Strangi ruling, the court determined possession or enjoyment is retained for these purposes if there is an express or implied agreement among them at the time of the transfer, whether or not the agreement is legally enforceable.

Although the LLC had some right to the income and the property of the FLP, its interest was determined to be de minimis, not much more than a token interest. The LLC, as the general partner, had the absolute discretion to make distributions. Because Bryan was the sole member of the LLC and was the agent for Anne, the court ruled that she effectively had the right to virtually all the income from her transferred assets. Additionally, the partnership agreement constituted an express agreement to that effect.

Because Anne had only $2.15 million in assets in her name after she completed the transfers to the FLP, and her will called for bequests of $1.45 million, a substantial estate tax liability was foreseeable. Accordingly, the court found that an implicit agreement existed that Bryan, as manager of the LLC, would distribute money from the FLP to the estate to pay the estate’s debts, bequests and tax.

After determining that Anne retained significant control and benefit from the assets transferred to the FLP, they next addressed whether the transfer was a bona fide sale. To qualify, the court had to determine if Anne’s transfers served any substantial nontax purpose. The estate argued the FLP was created to protect Anne from further instances of elder neglect and abuse as she had previously fallen while in the care of health care workers and had broken her hip. It also argued that the FLP was created to allow for succession of management assets, resolve the issue of third parties’ refusal to honor the general power of attorney and to allow for consolidated and streamlined management of Anne’s assets.

The court, troubled by the fact that the FLP was formed and funded less than one month before Anne’s death when her health had been in decline for some time, found Bryan’s testimony regarding the motivation to establish the FLP not credible. The court was more swayed by an email from Bryan’s attorney to the appraiser of the FLP inquiring about a “deeper discount.” Accordingly, the court held the establishment of the FLP was motivated by a desire to save estate taxes.

Having determined that Anne retained significant control and enjoyment from the transferred assets and that a bona fide sale did not exist, the court concluded that the date of death value of the assets transferred to the FLP were includible in her estate.

The next issue the court addressed was the Section 6662 accuracy-related penalty. Section 6662(c) defines negligence as any failure to make a reasonable attempt to comply with the IRC and disregard as any careless, reckless or intentional disregard. The court rejected the estate’s claim that Bryan acted in good faith in determining the estate tax liability, because he never considered, researched or understood the implications of Section 2036 and its effect on the estate tax liability. The court found a reduction of approximately $6.2 million in the estate’s reportable assets thanks to the seemingly inconsequential interposition of a limited partner interest between Anne and her assets on the eve of her death would strike a reasonable person in Bryan’s position as possibly too good to be true.

The decision underscores the importance of ensuring that transfers to FLPs are legitimate and that the transferor relinquishes sufficient control to avoid estate tax inclusion. Contact us to discuss your specific situation related to FLPs and estate tax. We are here to help.

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