Jul 1, 2009 12:00 PM

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David A. Handler, partner, & Alison E. Lothes, associate, in the Chicago office of Kirkland & Ellis LLP

• Taxpayer wins some, loses some in family limited partnership case

  In Estate of Miller v. Commissioner, T.C. Memo 2009-119, the Tax Court held that some, but not all, of the assets transferred to a family limited partnership (FLP) were includible in the decedent's gross estate under Internal Revenue Code Section 2036. The deciding factors were the decedent's health at the time of the transfer, the use and management of the transferred assets, and the amount left over in the decedent's possession to pay taxes anticipated on her estate.

  Valeria Miller's husband, Virgil J. Miller (Virgil Sr.), had managed the couple's assets and used a specific investment methodology of charting stocks. After retirement and until his death, he devoted his time to researching and actively investing in securities. He also trained his son, Virgil (Virgil Jr.), on how to use his methodology.

  In November 2001, several years after Virgil Sr. died, Valeria (at the age of 86) established an FLP, the “V/V Miller Family Limited Partnership” (MFLP). The purpose of MFLP was to continue Virgil Sr.'s investment strategies.

  Valeria was the sole contributor to MFLP but she simultaneously gifted 10 general partner units and 10 limited partner units to Virgil Jr. and 20 limited partner units to each of her other three children.

  Valeria did not actually fund MFLP until April 2002, at which time she transferred over $3.8 million (about 77 percent of her assets) of equity securities to the partnership from her investment accounts.

  Valeria's health through 2002 had been strong. But in the spring of 2003, she broke her hip. The doctors treating her discovered a heart condition that required surgery and further complications arose.

  While in the midst of receiving various treatments and surgeries, Valeria signed a letter authorizing the transfer of additional securities (about $880,000) to MFLP. Virgil Jr. had drafted the letter and, as trustee of her revocable trust, co-signed it. He also wrote a check from her revocable trust account to MFLP.

  The Tax Court held that Valeria's 2002 contributions were not includible in her estate under IRC Section 2036 because of the exception for bona fide transfers for full and adequate consideration. Section 2036(a) applies to transfers of property — that are not bona fide sales for adequate and full consideration — when the decedent retains the possession or enjoyment of the property or its income or the right to designate the people who will enjoy or possess the property or its income.

  Under Estate of Bongard v. Comm'r, 124 T.C. 95 (2005), to constitute a bona fide sale exception in the context of a transfer to a limited partnership, there must be a legitimate and significant non-tax reason for establishing the partnership and the transferor must have received partnership interests proportionate to the value of the property received. The Tax Court found that Valeria's interest in having her assets managed according to Virgil Sr.'s investment strategy was a legitimate non-tax reason. The court focused on the time Virgil Jr. spent actively trading and managing the assets in MFLP (40 hours per week), for which he was compensated, and the increase in trading activity with respect to the securities after transfer to MFLP. The court also noted that Valeria was healthy in 2002, there was no indication of significant health problems, and that she had retained enough of her own assets to support herself and cover her anticipated estate tax liability.

  The Tax Court held, however, that Valeria's 2003 contributions were not made for legitimate and significant non-tax reasons. Instead, the court found that Valeria's declining health was the actual motivation for the additional transfers. And, since the 2003 contributions depleted her personal assets such that MFLP ultimately had to make a distribution to its partners to provide her estate with funds to pay the estate tax, the court found that she had retained the possession and enjoyment of the assets transferred to MFLP in 2003.

  The court also noted that the 2002 transfers left her sufficient assets to support herself, but the 2003 transfers did not leave her with enough assets to pay the anticipated estate tax.

  While the ability to pay the estate tax did not drive the Miller decision, it certainly influenced it. This is in contrast to the opinion in Estate of Mirowski v. Comm'r, T.C. Memo 2008-74, in which the Tax Court found that transfers to a limited liability company were for legitimate and significant non-tax reasons even though the transferor did not keep enough assets to pay her gift or estate taxes.

  Therefore, while the assets contributed in 2002 to MFLP were not included in Valeria's estate under Section 2036, the assets transferred in 2003 were includible in her gross estate at their fair market value.

  Miller cautions against transferring clients' assets beyond the point at which their remaining assets can pay for estate tax without added funds from the partnership.

  Miller also reinforces a lesson learned in the recent Estate of Jorgenson v. Comm'r, T.C 2009-66. In Jorgenson, the Tax Court held there was no legitimate and significant non-tax purpose in part because there was no active management of securities transferred to the partnership under the family's professed “buy and hold” strategy. Together, Miller and Jorgenson indicate the importance of active management of partnership assets in furtherance of a specific investment philosophy.

  Interestingly, the Internal Revenue Service could have argued that because the partnership was formed and partnership interests transferred before it was funded, Valeria made an indirect gift of the assets rather than of partnership interests. The IRS prevailed using this argument in Shepherd v. Comm'r, 115 T.C. 376 (2000). But the IRS did not raise this issue in Miller.

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Topics of Interest

Estate Tax	Donor Advised Funds
GSTs	Family Offices
Private Foundations	Life Insurance
2010 Tax Act News	Industry Trends Surveys

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