I. Built-in Capital Gains
In Estate of Welch v. Comr., 208 F.3d 213 (6th Cir. 3/2000), the Court of Appeals held that a discount to reflect built-in capital gains of real property was appropriate, despite the fact that the corporation might avoid the capital gains tax by reinvesting the proceeds. Citing Eisenberg v. Comr., 155 F.3d 50 (2d Cir. 1998), acq. 199-4 I.R.B. 4, the court held that the principal issue was whether a hypothetical purchaser would take into account built-in capital gains in computing the value of the stock.
Similarly, the Tax Court allowed a 5% discount for built-in capital gains in Estate of Dunn, 79 TCM 1337 (2000), observing that a new owner could avoid the built-in capital gains tax by continuing to use the property over its entire useful life. According to the court, only if the buyer intended to liquidate in the “short-term” would the buyer seek a reduction in price for built-in capital gain.
II. Valuation Discounts
The Tax Court decision in Estate of Simplot, 112 T.C. 130 (3/1999), brief filed (9th Cir. 4/2000) was appealed to the Ninth Circuit. In Simplot, the Tax Court allocated a percent of equity of the entire corporation to 76 shares of voting stock, causing those shares to be worth $215,539 for estate tax purposes, rather than $2,650 as the taxpayer had reported.
The Tax Court, in Estate of Knight, 115 T.C.__ (No. 36) (11/2000), rejected an IRS attempt disregard transfers made to a Texas family limited partnership in valuing the gifts of limited partnership interests. The court reasoned that since the partnership was a valid entity under Texas law, it was also valid for federal tax purposes. While the case is helpful for its apparent recognition of the family limited partnership as a viable estate planning entity, the holding was double-edged: the court also disallowed the taxpayer’s claimed 44% discount, and allowed a discount of only 15%, which was substantially less than had been allowed in previous cases. The Knight decision has prompted commentators to suggest that the size of the valuation discount may be a point of contentious disagreement in the future. If this surmise is correct, the importance of obtaining an expert professional discount valuation in the context of transfers to family limited partnerships and LLCs is even more pronounced.
Another blow to the IRS in the family limited partnership discount arena came in Estate of Strangi, 115 T.C. ___ (No. 35) (11/2000), where the Tax Court allowed valuation discounts with respect to transfers effected two months before the decedent’s death. Although the Tax Court doubted some of the asserted business motives for the partnerships, it stated that Congress, in enacting the partnership tax laws, did not intend to tax assets of a validly-existing partnership as if they had been owned directly by the decedent. As in Knight, supra, the Tax Court trimmed the allowable discount, from 43.75% as claimed by the taxpayer, to 31%. The court also noted that the 31% discount allowed was based on the Service’s failure to challenge it, and as a result might be “overly generous to petitioner.”
In Shepherd v. Comr., 115 T.C. ___ (No. 30) (10/2000), the taxpayer transferred land and stock to a partnership of which the taxpayer’s children were named as limited partners. However, the children did not actually sign the agreement until after the property was transferred into the partnership. The Tax Court held that the children had received gifts of land and stock, rather than of partnership interests, reasoning that the partnership did not exist until the children signed the partnership agreement. This case vividly illustrates the necessity of respecting the formalities when creating a family limited partnership. The partnership should be formed, and documents executed prior to deeding any property into the partnership. Only after completing these steps should the parent make gifts of partnership interests.
In Estate of Reichardt v. Comr. 114 T.C. No. 9 (2000), the entire value of assets transferred to a family limited partnership were included in the decedent’s estate under IRC §2036. The Tax Court found an implied agreement that the decedent would continue to possess and enjoy the property and retain a right to income. The Court noted that “[n]othing changed except legal title.” The case is of concern to estate planners since IRC §2036(a) had not found routine application in the context of family limited partnerships; the fiduciary duty of the manager (or partner) was thought to preclude its relevance. If IRC §2036 is to be avoided, the fiduciary duties of the managing member of the entity must be taken seriously. A mere recital in the operating agreement of the manager’s duties may be insufficient.
In Kerr v. Comr., 113 T.C. 449, (12/1999) the Tax Court rejected an IRS attempt to disallow discounts for transfers of family limited partnership interests based on the argument that certain restrictions in the partnership agreement violated IRC §2704(b). Granting summary judgment to the taxpayer, the court held that the restrictions in the agreement were not “applicable restrictions” for the purpose of IRC §2704(b). Similarly, in Estate of Harper v. Comr., the Tax Court, citing Estate of Kerr, supra, held that partnership restrictions were not applicable restrictions under IRC §2704(b), because they were no more restrictive than conditions imposed by state law. Thus, the decision appeared to validate the old saw that restrictions in a partnership agreement should be no more restrictive than those under state law.
The Tax Court, in Estate of Busch, 79 TCM 1276 (2000), allowed a 10% undivided interest discount in real property, which represented the “reasonable costs of partition.” In Estate of Brocato, 78 TCM 1243 (1999), the Tax Court allowed a 20% undivided interest discount. The court also allowed an 11% “blockage” discount, which reflected the expected decrease in market price if multiple properties were introduced into the market simultaneously.
III. Power of Attorney Gifts
The Tax Court, in Estate of Swanson v. U.S., 46 Fed. Cl. 338 (3/2000) granted summary judgment in favor of the IRS, holding that under California state law, the power to make gifts under a power of attorney may not be implied. The case underscores the importance of including such a power in New York powers of attorney. If the form power of attorney used contains a provision explicitly authorizing annual exclusion gifts, broader powers should be included if gifts in excess of the annual exclusion are desired.
IV. Estate Taxes & Returns
In Estate of Devlin v. Comr., T.C. Memo 1999-406 (12/1999), gifts authorized by a court before, but not made until after the death of the decedent, were included in the gross estate. The Tax Court held that no constructive trust arose in favor of the beneficiaries since the gifts were not required.
In Estate of Smith v. Comr., 198 F.3d 515 (5th Cir. 12/1999), the Tax Court, held that the estate could deduct only $681,139, the amount of a debt which it eventually paid to settle a claim. In reversing the Tax Court decision, the Fifth Circuit stated that the estate was allowed to deduct the entire amount of the liability “as of” the date of the decedent’s death, which was $2.48 million. The Fifth Circuit ruled that post-death events are irrelevant when claims “are for sums certain and are legally enforceable as of the date of death.” The IRS has stated that it will not follow the decision.
In Armstrong v. Comr., 114 T.C. 94 (2/2000), the decedent made large taxable gifts in 1991 and 1992, and paid gift taxes of $4.7 million. As a result of these gifts, the decedent was nearly insolvent at his death in 1993. Although an estate tax return was filed, gift taxes occasioned by application of the three-year rule of IRC § 2035(c) were not included with the return. The IRS assessed a deficiency of $2.3 million. The donees of the gifts claimed that they were not liable for payment of estate taxes, since the stock given to them was not the source of the estate tax deficiency. Nevertheless, the Tax Court looked to the beneficiaries for payment of the estate taxes, finding authority, somewhat implausibly, in IRC §6324(a)(2), which imposes personal liability upon transferees of property included in the decedent’s gross estate under IRC §§2034 to 2042.
V. Tax Payment Provisions
Estate of Miller v. Comr., 209 F3d. 720 (5th Cir. 2/2000), aff’g per curium T.C. Memo, 1998-416, illustrates the importance of consistent tax payment provisions in will and trust documents. In this case, the decedent’s will stated that all estate taxes were to be “borne by my residuary estate . . . as an expense of administration, without apportionment and without contribution or reimbursement from anyone.” The decedent’s will left half of her residuary estate to her husband, and half to a revocable trust. The revocable trust authorized the trustee to pay estate taxes from the trust fund.
The executor in Miller apportioned all of the estate taxes to the nonmarital portion of the residuary estate passing under the trust. The decision of the Tax Court, upheld on appeal to the 5th Circuit, stated that the decedent’s will had been clear in providing that there be no discrimination between marital and nonmarital residual beneficiaries. Accordingly, estate taxes were required to be paid in part from the deductible marital share. The result of the decision, a reflection of imprecisely drafted documents, caused estate taxes to be paid and to reduce the marital share, which was deductible. The case illustrates the importance of a careful review of all estate planning documents in order to ensure that tax payment provisions are consistent and clear.
VI. Annual Exclusion Gifts
The Tax Court in Estate of Bies v. Comr., T.C. Memo 2000-338 (11/2000), recognized and rejected an idea sometimes proposed by taxpayers: make annual exclusion gifts to others with an “understanding” that the donee then regift the property to the donor’s “ultimate” beneficiary. In Bies, gifts of a business interest were made to sons and daughters-in-law, the latter of whom quickly re-gifted the interest to sons. The court held that the “facts and circumstances” evidenced the intent of the decedent to make indirect gifts to her sons. Taxpayers should be dissuaded from this type of transaction, which constitutes a thinly-veiled attempt to leverage the annual exclusion. Though perhaps not easily distinguishable from “Crummey” annual exclusion gifts, which have been sanctioned by the courts (over the strenuous objection of the IRS), the type of gifts attempted in Bies dispenses with even the legal fiction upon which Crummey gifts are predicated.
VII. Disclaimers
In Chamberlain v. Comr., T.C. Memo 1999-181, briefs filed (9th Cir. 11/2000), the Tax Court held that an unsigned disclaimer which did not list specific assets to be disclaimed failed to accomplish a valid disclaimer. The estate’s attorney had prepared a disclaimer listing the total value of assets to be disclaimed, but pending a determination of a value of the estate’s assets, a list specific assets was not prepared. The surviving spouse died without executing the disclaimer. The court noted that valid disclaimer under IRC §2518 must (i) be written; (ii) irrevocably refuse to accept the assets passing from the decedent’s estate; and (iii) specifically identify the disclaimed property.
VIII. Imputed Interest
Where taxpayers advanced monies to a wholly-owned family corporation to pay expenses, recorded the advances in the corporate books as increases in “shareholder loan accounts,” and were later reimbursed without interest, Tax Court held in Estate of Hoffman v. Comr, T.C. Memo 1999-395 (12/99) that advances were demand loans rather than capital contributions, which required the shareholders to report imputed interest under IRC §7872. The case illustrates the principle that the taxpayer, once having chosen the form of a transaction, will usually be foreclosed from arguing that the substance of the transaction should prevail over its form.
IX. Income Tax Liens
In Drye Jr., v. U.S., 526 U.S. 1063 (12/99), aff’g 152 F.3d 892 (8th Cir. 1998), the beneficiary of an estate who owed the IRS $325,000 in income tax disclaimed his legacy. Although the disclaimer was valid under Arkansas law, the district court held that the disclaimer was void and fraudulent against the IRS where the disclaimed assets went first to the debtor’s daughter, and then into a trust for the benefit of the daughter and her parents. The trust was a discretionary trust which contained spendthrift provision.
The Drye decision was upheld on appeal to the Eighth Circuit and again on appeal to the Supreme Court. An opinion written by Justice Ginsburg stated that the tax law looks to federal law, rather than state law, in determining whether a taxpayer has a beneficial interest in any property upon which the IRS can levy. Although state law determines a taxpayer’s rights in property, federal law determines whether these rights are “property” for purposes of a tax levy.
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2000 Estate and Gift Tax Decisions of Note
I. Built-in Capital Gains
In Estate of Welch v. Comr., 208 F.3d 213 (6th Cir. 3/2000), the Court of Appeals held that a discount to reflect built-in capital gains of real property was appropriate, despite the fact that the corporation might avoid the capital gains tax by reinvesting the proceeds. Citing Eisenberg v. Comr., 155 F.3d 50 (2d Cir. 1998), acq. 199-4 I.R.B. 4, the court held that the principal issue was whether a hypothetical purchaser would take into account built-in capital gains in computing the value of the stock.
Similarly, the Tax Court allowed a 5% discount for built-in capital gains in Estate of Dunn, 79 TCM 1337 (2000), observing that a new owner could avoid the built-in capital gains tax by continuing to use the property over its entire useful life. According to the court, only if the buyer intended to liquidate in the “short-term” would the buyer seek a reduction in price for built-in capital gain.
II. Valuation Discounts
The Tax Court decision in Estate of Simplot, 112 T.C. 130 (3/1999), brief filed (9th Cir. 4/2000) was appealed to the Ninth Circuit. In Simplot, the Tax Court allocated a percent of equity of the entire corporation to 76 shares of voting stock, causing those shares to be worth $215,539 for estate tax purposes, rather than $2,650 as the taxpayer had reported.
The Tax Court, in Estate of Knight, 115 T.C.__ (No. 36) (11/2000), rejected an IRS attempt disregard transfers made to a Texas family limited partnership in valuing the gifts of limited partnership interests. The court reasoned that since the partnership was a valid entity under Texas law, it was also valid for federal tax purposes. While the case is helpful for its apparent recognition of the family limited partnership as a viable estate planning entity, the holding was double-edged: the court also disallowed the taxpayer’s claimed 44% discount, and allowed a discount of only 15%, which was substantially less than had been allowed in previous cases. The Knight decision has prompted commentators to suggest that the size of the valuation discount may be a point of contentious disagreement in the future. If this surmise is correct, the importance of obtaining an expert professional discount valuation in the context of transfers to family limited partnerships and LLCs is even more pronounced.
Another blow to the IRS in the family limited partnership discount arena came in Estate of Strangi, 115 T.C. ___ (No. 35) (11/2000), where the Tax Court allowed valuation discounts with respect to transfers effected two months before the decedent’s death. Although the Tax Court doubted some of the asserted business motives for the partnerships, it stated that Congress, in enacting the partnership tax laws, did not intend to tax assets of a validly-existing partnership as if they had been owned directly by the decedent. As in Knight, supra, the Tax Court trimmed the allowable discount, from 43.75% as claimed by the taxpayer, to 31%. The court also noted that the 31% discount allowed was based on the Service’s failure to challenge it, and as a result might be “overly generous to petitioner.”
In Shepherd v. Comr., 115 T.C. ___ (No. 30) (10/2000), the taxpayer transferred land and stock to a partnership of which the taxpayer’s children were named as limited partners. However, the children did not actually sign the agreement until after the property was transferred into the partnership. The Tax Court held that the children had received gifts of land and stock, rather than of partnership interests, reasoning that the partnership did not exist until the children signed the partnership agreement. This case vividly illustrates the necessity of respecting the formalities when creating a family limited partnership. The partnership should be formed, and documents executed prior to deeding any property into the partnership. Only after completing these steps should the parent make gifts of partnership interests.
In Estate of Reichardt v. Comr. 114 T.C. No. 9 (2000), the entire value of assets transferred to a family limited partnership were included in the decedent’s estate under IRC §2036. The Tax Court found an implied agreement that the decedent would continue to possess and enjoy the property and retain a right to income. The Court noted that “[n]othing changed except legal title.” The case is of concern to estate planners since IRC §2036(a) had not found routine application in the context of family limited partnerships; the fiduciary duty of the manager (or partner) was thought to preclude its relevance. If IRC §2036 is to be avoided, the fiduciary duties of the managing member of the entity must be taken seriously. A mere recital in the operating agreement of the manager’s duties may be insufficient.
In Kerr v. Comr., 113 T.C. 449, (12/1999) the Tax Court rejected an IRS attempt to disallow discounts for transfers of family limited partnership interests based on the argument that certain restrictions in the partnership agreement violated IRC §2704(b). Granting summary judgment to the taxpayer, the court held that the restrictions in the agreement were not “applicable restrictions” for the purpose of IRC §2704(b). Similarly, in Estate of Harper v. Comr., the Tax Court, citing Estate of Kerr, supra, held that partnership restrictions were not applicable restrictions under IRC §2704(b), because they were no more restrictive than conditions imposed by state law. Thus, the decision appeared to validate the old saw that restrictions in a partnership agreement should be no more restrictive than those under state law.
The Tax Court, in Estate of Busch, 79 TCM 1276 (2000), allowed a 10% undivided interest discount in real property, which represented the “reasonable costs of partition.” In Estate of Brocato, 78 TCM 1243 (1999), the Tax Court allowed a 20% undivided interest discount. The court also allowed an 11% “blockage” discount, which reflected the expected decrease in market price if multiple properties were introduced into the market simultaneously.
III. Power of Attorney Gifts
The Tax Court, in Estate of Swanson v. U.S., 46 Fed. Cl. 338 (3/2000) granted summary judgment in favor of the IRS, holding that under California state law, the power to make gifts under a power of attorney may not be implied. The case underscores the importance of including such a power in New York powers of attorney. If the form power of attorney used contains a provision explicitly authorizing annual exclusion gifts, broader powers should be included if gifts in excess of the annual exclusion are desired.
IV. Estate Taxes & Returns
In Estate of Devlin v. Comr., T.C. Memo 1999-406 (12/1999), gifts authorized by a court before, but not made until after the death of the decedent, were included in the gross estate. The Tax Court held that no constructive trust arose in favor of the beneficiaries since the gifts were not required.
In Estate of Smith v. Comr., 198 F.3d 515 (5th Cir. 12/1999), the Tax Court, held that the estate could deduct only $681,139, the amount of a debt which it eventually paid to settle a claim. In reversing the Tax Court decision, the Fifth Circuit stated that the estate was allowed to deduct the entire amount of the liability “as of” the date of the decedent’s death, which was $2.48 million. The Fifth Circuit ruled that post-death events are irrelevant when claims “are for sums certain and are legally enforceable as of the date of death.” The IRS has stated that it will not follow the decision.
In Armstrong v. Comr., 114 T.C. 94 (2/2000), the decedent made large taxable gifts in 1991 and 1992, and paid gift taxes of $4.7 million. As a result of these gifts, the decedent was nearly insolvent at his death in 1993. Although an estate tax return was filed, gift taxes occasioned by application of the three-year rule of IRC § 2035(c) were not included with the return. The IRS assessed a deficiency of $2.3 million. The donees of the gifts claimed that they were not liable for payment of estate taxes, since the stock given to them was not the source of the estate tax deficiency. Nevertheless, the Tax Court looked to the beneficiaries for payment of the estate taxes, finding authority, somewhat implausibly, in IRC §6324(a)(2), which imposes personal liability upon transferees of property included in the decedent’s gross estate under IRC §§2034 to 2042.
V. Tax Payment Provisions
Estate of Miller v. Comr., 209 F3d. 720 (5th Cir. 2/2000), aff’g per curium T.C. Memo, 1998-416, illustrates the importance of consistent tax payment provisions in will and trust documents. In this case, the decedent’s will stated that all estate taxes were to be “borne by my residuary estate . . . as an expense of administration, without apportionment and without contribution or reimbursement from anyone.” The decedent’s will left half of her residuary estate to her husband, and half to a revocable trust. The revocable trust authorized the trustee to pay estate taxes from the trust fund.
The executor in Miller apportioned all of the estate taxes to the nonmarital portion of the residuary estate passing under the trust. The decision of the Tax Court, upheld on appeal to the 5th Circuit, stated that the decedent’s will had been clear in providing that there be no discrimination between marital and nonmarital residual beneficiaries. Accordingly, estate taxes were required to be paid in part from the deductible marital share. The result of the decision, a reflection of imprecisely drafted documents, caused estate taxes to be paid and to reduce the marital share, which was deductible. The case illustrates the importance of a careful review of all estate planning documents in order to ensure that tax payment provisions are consistent and clear.
VI. Annual Exclusion Gifts
The Tax Court in Estate of Bies v. Comr., T.C. Memo 2000-338 (11/2000), recognized and rejected an idea sometimes proposed by taxpayers: make annual exclusion gifts to others with an “understanding” that the donee then regift the property to the donor’s “ultimate” beneficiary. In Bies, gifts of a business interest were made to sons and daughters-in-law, the latter of whom quickly re-gifted the interest to sons. The court held that the “facts and circumstances” evidenced the intent of the decedent to make indirect gifts to her sons. Taxpayers should be dissuaded from this type of transaction, which constitutes a thinly-veiled attempt to leverage the annual exclusion. Though perhaps not easily distinguishable from “Crummey” annual exclusion gifts, which have been sanctioned by the courts (over the strenuous objection of the IRS), the type of gifts attempted in Bies dispenses with even the legal fiction upon which Crummey gifts are predicated.
VII. Disclaimers
In Chamberlain v. Comr., T.C. Memo 1999-181, briefs filed (9th Cir. 11/2000), the Tax Court held that an unsigned disclaimer which did not list specific assets to be disclaimed failed to accomplish a valid disclaimer. The estate’s attorney had prepared a disclaimer listing the total value of assets to be disclaimed, but pending a determination of a value of the estate’s assets, a list specific assets was not prepared. The surviving spouse died without executing the disclaimer. The court noted that valid disclaimer under IRC §2518 must (i) be written; (ii) irrevocably refuse to accept the assets passing from the decedent’s estate; and (iii) specifically identify the disclaimed property.
VIII. Imputed Interest
Where taxpayers advanced monies to a wholly-owned family corporation to pay expenses, recorded the advances in the corporate books as increases in “shareholder loan accounts,” and were later reimbursed without interest, Tax Court held in Estate of Hoffman v. Comr, T.C. Memo 1999-395 (12/99) that advances were demand loans rather than capital contributions, which required the shareholders to report imputed interest under IRC §7872. The case illustrates the principle that the taxpayer, once having chosen the form of a transaction, will usually be foreclosed from arguing that the substance of the transaction should prevail over its form.
IX. Income Tax Liens
In Drye Jr., v. U.S., 526 U.S. 1063 (12/99), aff’g 152 F.3d 892 (8th Cir. 1998), the beneficiary of an estate who owed the IRS $325,000 in income tax disclaimed his legacy. Although the disclaimer was valid under Arkansas law, the district court held that the disclaimer was void and fraudulent against the IRS where the disclaimed assets went first to the debtor’s daughter, and then into a trust for the benefit of the daughter and her parents. The trust was a discretionary trust which contained spendthrift provision.
The Drye decision was upheld on appeal to the Eighth Circuit and again on appeal to the Supreme Court. An opinion written by Justice Ginsburg stated that the tax law looks to federal law, rather than state law, in determining whether a taxpayer has a beneficial interest in any property upon which the IRS can levy. Although state law determines a taxpayer’s rights in property, federal law determines whether these rights are “property” for purposes of a tax levy.
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