Family limited partnerships have been a durable estate planning vehicle, with courts supporting significant discounts for lack of marketability and control. Often the transferors retain a meaningful economic interest in the entities. Many times a charitable lead annuity trust (CLAT) is funded with units of a family limited partnership (FLP). The CLAT pays charity for a fixed term, with the remainder interest passing to children and/or grandchildren. The payout rate to charity often “zeroes out” the taxable value of the remainder interest. Ideally, the donor has removed the FLP from the gross estate, taken a significant charitable deduction for transfer tax purposes and has left family members with the economic benefit. Often an irrevocable living trust and grantor retained annuity are created in concert with the FLP and CLAT.
For some time, the IRS has unsuccessfully challenged the claimed discounts.
If sec. 2036(a)(1) is successfully invoked, then property transferred by a decedent is included in the gross estate at its date of death value. If the original transfer was a taxable gift, then 2036(a)(1) operates to include the post-transfer appreciation in the gross estate. In effect, all valuation discounts are ignored. Even worse for the decedent, the property transferred to the partnership is included in the gross estate regardless of who owns the beneficial interest in the entity, such as a limited partnership.
Moore also illustrates the huge difficulty in effective deathbed planning. The Tax Court noted Mr. Moore had received a diagnosis of a terminal illness. His primary asset, the farm, was transferred to a FLP and sold within days of transfer. The Tax Court saw the sale as undermining the credibility of the estate’s assertion that the FLP was created for the active management of the farm. The estate could not present any credible concerns of creditors. Nor could the Tax Court find significant nontax reasons for the formation of the FLP. It concluded that the sale of the farm was not a bona fide sale for adequate and full consideration that would have made sec. 2036 (a)(1) inapplicable. Additionally, the transferor continued to live on the farm after its sale and used the sales proceeds to make gifts to family members and pay personal expenses.
The Tax Court determined the estate was not entitled to charitable deductions for two reasons. The valuation adjustment clause was part of the irrevocable trust, and neither the farm nor its sales proceeds were deemed not part of the irrevocable trust. It also held that the formula clause created the contingency of the charitable transfer requiring an audit of the estate’s tax return.
The 9th Circuit denied the charitable deduction for the first reason. It did not see the irrevocable trust under any obligation to transfer the sales proceeds to the living trust and ultimately to the CLAT.
- Some plans have great potential to do more harm than good when there is a low likelihood of success. One of the high hurdles of deathbed planning is that taxable gifts still enter into the calculation of tentative tax as an adjusted taxable gift, though not as an asset in gross estate. The goal of technique is removing appreciation from the estate over a meaningful time frame.
- Transfers near death invite audits, litigation and delay. It was noteworthy the decedent incurred nearly half a million dollars in legal fees for establishing the multiple trusts. Approximately another half million was incurred in estate administration.
- Do not assume charitable gifts will bail the estate out from higher than expected valuations. Remember that, while the charitable transfer deduction is unlimited, the asset must be included in the gross estate.2 All documents need to be drafted precisely to meet this requirement.
- Moore et al v. Comm’r, 128 A.F.T.R.2d, 2021-6604 (9th)(Nov. 8, 2021) affirmed the result of the US Tax Court in Estate of Moore v. Commissioner, T.C. Memo, 2020-40 (April 7, 2020).
- 2055(d) notes the “amount of the deduction…shall not exceed the value of the transferred property required to be included in the gross estate.”