December 18, 2018
By: Ira W. Zlotnick
Many taxpayers have incorporated "so-called" family partnerships or family limited liability companies into their planning, and in many instances have transferred, often at discounted values, partnership or membership interests to trusts for the benefit of family members in order to remove the interests from their estates at such discounted values. While there have not been a plethora of cases of late involving such planning, one case that has raised the eyebrows of many estate planners is the recent Tax Court decision, Estate of Powell v. Commissioner. Although this case involves many bad facts, the case should not be dismissed out of hand, and should instead serve to motivate clients to review and, if necessary, revise their planning.
Nancy Powell died on August 15, 2008. Several days earlier, Mrs. Powell's son, Jeffrey, acting under a power of attorney, formed a limited partnership, named himself as a general partner and transferred approximately $10,000,000 to the partnership from his mother's revocable trust in exchange for a 99% limited partnership interest. Jeffrey then transferred his mother's 99% limited partnership interest to a charitable lead annuity trust (CLAT) which was to pay an annuity to Mrs. Powell's foundation for the rest of her life and then distribute the remaining trust assets to trusts for Jeffrey and his brother. Following Mrs. Powell's death, Jeffrey reported the value of the 99% interest that was gifted to the CLAT at $7,500,000, after accounting for a 25% discount for lack of marketability and lack of control.
For various reasons the Tax Court held that the gift to the CLAT was ineffective and that the assets of the limited partnership should be included in Mrs. Powell's estate for estate tax purposes. Initially, the Tax Court found that the gift exceeded Jeffrey's actual authority under the power of attorney (which limited gift giving to the annual exclusion amount - $14,000 at the time). In addition, the Tax Court found that even if the gift were valid, the limited partnership interest would be includible in her estate under Section 2036(a)(2) of the Internal Revenue Code, since Mrs. Powell had the ability, in her capacity as a limited partner, when acting with the other partners (i.e. her sons), to dissolve the partnership and thus was deemed to have retained the right to designate the person(s) who could enjoy the property. The Tax Court found that an exception under Section 2036 for transfers made in exchange for full and adequate consideration was not applicable because there was no economic substance for the planning aside from the tax savings.
The Tax Court's primary reliance on Section 2036(a)(2) in the Powell case is what has raised the eyebrow of many estate planners since many estate plans involve the transferor retaining some interest in or control over the entity. Such control may exist merely by retaining an interest as a general or limited partner or member which grants the right to vote for the dissolution of the entity. Although we believe that the Tax Court ruling was largely driven by the egregious facts of this particular case, we still think that it is advisable for clients who have created these types of vehicles in the past to review their planning to determine whether any remedial measures should be taken to better ensure that their entities remain excluded from their estates.