The recent case of Estate of Fields v. Commissioner, T.C. 2024-90 (Tax Ct. 9-26-24), provides a textbook example of a bad-facts family limited partnership (FLP) that caused estate tax inclusion of the property transferred to the FLP under both Internal Revenue Code Section 2036(a)(1) and (2) with loss of discounts for lack of control and lack of marketability. The court applied the Tax Court’s 2017 holding in Estate of Powell v. Comm’r, 148 T.C. 392 (2017), which said that the ability of the decedent as a limited partner to join together with other partners to liquidate the FLP constitutes an IRC Section 2036(a)(2) estate tax trigger and raises the specter of accuracy-related penalties.
Businesswoman Designates Successor
Anne Milner Fields inherited an oil business when her husband passed away in the 1960s. She ran that business well and, over time, became a successful businessperson. She took a particular interest in her great nephew, Bryan Milner, educating him, mentoring him and designating him as the successor to her wealth. In her later years, she relied on Bryan to take care of her and manage her assets, entrusting him with a general durable power of attorney. Bryan ultimately exercised this POA to implement an estate plan involving an FLP about a month before Anne’s death on June 23, 2016.
Limited Partnership Formed
On May 20, 2016, Bryan formed AM Fields Management, of which he was the sole member and manager. He then formed AM Fields on May 26, 2016, for which AM Fields Management was the general partner and Anne was the limited partner. In forming AM Fields, Bryan signed the partnership agreement both as the manager of AM Fields Management and as Anne’s agent under her POA with respect to her LP interest. He then used his POA to transfer to AM Fields approximately $17 million of Anne’s assets (constituting more than 85% of her wealth). He also caused AM Fields Management to contribute $1,000 to AM Fields as its capital contribution. In exchange for the partnership contributions, Anne received a 99.9941% LP interest in AM Fields, and AM Fields Management received a 0.0059% GP interest.
After Anne passed away, Bryan obtained an appraisal of Anne’s LP interest in AM Fields. The appraiser valued the interest at $10.8 million as of Anne’s date of death, reducing the approximately $17 million in assets that she contributed to the FLP approximately one month before her death by a 36.25% aggregate discount for lack of control and lack of marketability. As Anne’s estate executor, Bryan reported this discounted value on the estate’s Form 706 estate tax return.
Notice of Deficiency Issued
The IRS audited the estate tax return and attacked the claimed discount under Section 2036(a)(1) and (2). In a Notice of Deficiency, the IRS asserted that Section 2036(a) applies such that the gross estate includes the full date-of-death value of Anne’s assets that were contributed to AM Fields without any discount for lack of control or lack of marketability. The IRS also asserted an accuracy-related penalty against the estate under IRC Sections 6662(a) and (b)(1) due to negligence or disregard of rules or regulations. Litigation in the Tax Court followed.
Section 2036 Analysis
The Tax Court observed that there are three requirements for property to be included in the gross estate under Section 2036(a): (1)the decedent must have made an inter vivos transfer of property (which was undisputed here); (2) the decedent must have retained an interest or right specified in Section 2036(a)(1) or (2) in the transferred property that they didn’t relinquish until death; and (3) the transfer must not have constituted a bona fide sale for adequate and full consideration.
Retained Interest under Section 2036(a)(1)
The court had little difficulty finding that Anne retained an interest in the property that she transferred to the FLP under section 2036(a)(1). As a result of Bryan’s dual role as attorney-in-fact under Anne’s POA and as the manager of the GP, Anne had the right to income from her transferred assets. The court also found that Anne and Bryan implicitly agreed that Bryan would make distributions from the partnership to satisfy Anne’s expenses, debts and bequests. This was evidence of Anne’s retained interest in the assets transferred to the partnership. The court considered de minimis the $1,000 GP interest that AM Fields acquired in the FLP, so it didn’t give rise to a pooling of interests to potentially alter this result.
Retained Right to Designate Enjoyment of Property
Relying on Powell, the court then held that estate tax inclusion was also triggered under Section 2036(a)(2) by virtue of Anne’s retention of the right, as an LP, to act in conjunction with the GP to dissolve the FLP and cause its liquidation.
Bona Fide Sale Exception to Section 2036 Not Available
The court next considered whether Section 2036’s exception for transfers constituting a “bona fide sale for an adequate and full consideration in money or money’s worth” might spare the taxpayer from Section 2036’s reach. This exception requires a full and adequate consideration for the inter vivos transfer and a “bona fide sale.” The bona fide sale prong, in turn, requires a “substantial nontax purpose.”
Relying principally on Bryan’s testimony, the estate argued that there were four substantial non-tax purposes behind Anne’s capital contributions to the FLP:
1. The FLP protected Anne from further instances of financial elder abuse (which she had sustained several years earlier).
2. The FLP allowed for succession management of assets by permitting Bryan to designate his successor.
3. The FLP resolved concerns that third parties, such as banks, may refuse to honor Anne’s POA (which had occurred several years earlier).
4. The FLP allows for consolidated and streamlined management of assets.
The court found Bryan’s testimony that Anne was actually motivated by any of the above four objectives to contribute her assets to the FLP not credible. Rather, the court found the establishment of the FLP was motivated by the desire to save estate taxes and considered particularly telling an email from Bryan’s attorney to the appraiser that inquired about “obtaining a deeper discount” for tax purposes. Further, the timeline for the establishment and funding of the FLP coincided with Anne’s precipitous decline in health, as she suffered from severe Alzheimer’s and died approximately one month after the partnership was funded. In addition, the transfers of assets to the FLP depleted Anne’s liquidity to the point that the estate couldn’t pay Anne’s bequests under her will or its estate tax liability without receiving substantial distributions from the FLP. Given these circumstances, the court determined that the stated on-tax purposes were post hoc “theoretical justifications” rather than “actual motivations.” The estate, therefore, failed to meet its burden of proof that the transfers to the FLP constituted bona fide sales to qualify for the exception to Section 2036.
Amount of the Section 2036 Inclusion
The court then addressed the amount of the Section 2036 inclusion and relied on Estate of Moore, T.C. Memo. 2020-40 (2020) for its analysis. Under Moore, one must consider the date-of-death value of both the limited partnership interest (under Section 2033) and the transferred partnership property (under Section 2036) and then offset against it under Section 2043(a) the value of the transferred property as of the date of transfer. Because neither party argued that there was appreciation or depreciation in the value of the transferred property between the date of transfer and the date of death, the Section 2033 and Section 2043(a) components canceled each other out, producing estate tax inclusion of the date-of-death value of the transferred property without any discount.
Accuracy-Related Penalty
Finally, the court reviewed the IRS’ imposition of a 20% accuracy-related penalty under IRC Sections 6662(a) and (b)(1) on the underpayment of estate tax required to be shown on the estate tax return due to either negligence or the disregard of rules or regulations. Section 6662(c) provides that the term “negligence” includes any failure to make a reasonable attempt to comply with the IRC, and the term “disregard” includes any careless, reckless or intentional disregard.
In his capacity as executor, the estate argued Bryan had reasonable cause for any underpayment and acted in good faith in determining the estate tax liability. The court rejected this assertion because Bryan never contended that he personally considered, researched or understood the implications of Section 2036 upon the estate tax liability. Moreover, the record didn’t show that Bryan relied in good faith on an advisor’s judgment in discounting the value of Anne’s LP interest without considering the application of Section 2036. The estate, therefore, failed to meet its burden of establishing reasonable cause and consequently was liable for the 20% accuracy-related penalty on the underpayment of estate tax.
