Jul 1, 2006 12:00 PM, Rorie M. Sherman Editor in Chief

By: Rorie M. Sherman Editor in Chief

From David A. Handler, partner in the Chicago office of Kirkland & Ellis LLP, we have this report:

• Negotiation is not required for a transaction to be considered arm's-length. In Huber v. Commissioner, TC Memo. 2006-96 issued May 9, the Tax Court held that transfers of closely held stock among family members, trusts and nonprofit organizations were arm's-length transactions, so that the gift tax value of transfers to family members was correctly based on valuation reports used for shareholder stock transactions.

  The privately held company had approximately 250 shareholders comprised of family members, a family foundation and several independent charities. For many years, the same firm prepared an annual valuation report of the company, using the same methodology and applying a 50 percent lack of marketability discount.

  The taxpayers made gifts of the stock, reporting on their federal gift tax returns the value that had been set in the valuation reports. As evidence, the taxpayers produced 90 sales of stock that had taken place over the years, each based on the values assigned to the transfers of the stock by valuation reports.

  The Tax Court held that the sales the family produced as evidence were arm's-length because: (1) many (although not all) occurred between parties that were distantly related or unrelated and who had fiduciary obligations to obtain the best price; (2) the sellers were not under any compulsion to sell; (3) the sellers reasonably relied on a reputable firm's independent valuation of the stock; and (4) there was no evidence of donative intent in the transactions using the valuation price to buy and sell the company's stock.

  Interestingly, the court also held that negotiation is not a necessary element of an arm's-length transaction.

  Finally, the court held that the Internal Revenue Service's argument that the shareholders failed to obtain the maximum price for their shares because they did not offer their shares for sale to the public ran contrary to the recognized right of shareholders in a closely held company to remain private, citing Morrissey, 243 F.3d 1145, rev'g Kaufman Est., 77 TCM 1779.

• Estate beneficiaries are permitted to file malpractice claims against estate-planning lawyers in Texas. The Supreme Court of Texas has joined what it said was “an overwhelming majority of jurisdictions” in granting at least some intended beneficiaries the right to file malpractice claims against attorneys who may have provided bad estate-planning advice. In Belt v. Oppenheimer, Blend, Harrison & Tate, No. 04-0681 (issued May 5), the court held that two intended beneficiaries of an estate have a right to sue for malpractice on behalf of the estate, but only in their capacities as executors of the estate. In the past, the Texas Supreme Court declined to allow such suits, stating that the potential for conflicts between the estate-planning lawyer's duty to the client and his duty to beneficiaries outweighs the advantage of providing a remedy against negligent estate lawyers.

  The court explained that these policy considerations do not apply to suits by personal representatives because, unlike cases “when disappointed heirs seek to dispute the size of their bequest or their omission from an estate plan,” these policy considerations do not apply “when an estate's personal representative seeks to recover damages incurred by the estate itself.” Therefore, this decision limited such suits to those filed by the executor of the estate, and did not open the door to beneficiaries of the estate to file.

  Under traditional common law principles, beneficiaries cannot sue estate-planning counsel; only the testator or grantor that was actually represented by the estate-planning lawyers may sue those attorneys. But by the time estate-planning errors become known, the testator is usually dead and unable to sue. Nationwide, courts have been relaxing traditional privity-of-contract rules to provide a cause of action under which negligent estate-planning lawyers can be held accountable for their mistakes. According to the opinion in Belt, only eight states still bar such suits by beneficiaries: Alabama, Arkansas, Maine, Maryland, Nebraska, New York, Ohio and Virginia.

• FLP assets are included in an estate; purported loans were in fact distributions. In Estate of L. Rosen, TC Memo. 2006-115 (issued June 2), the Tax Court held that property transferred by Lillie Rosen to a family limited partnership (FLP) was includible in her estate. The court found that there was an implied agreement among the parties to the FLP that Rosen would maintain the economic benefit of the transferred property, and thus she retained the right to the income from the property for purposes of Internal Revenue Code Section 2036(a)(1). The facts supporting this finding included: (1)The FLP's funds were used to pay her living expenses, to make gifts to her descendants, to pay bequests under her trust and to pay the expenses of her estate; and (2) Rosen was elderly and in poor health when the assets were transferred to the FLP.

  The court also held that the exception contained in Section 2036 for “a bona fide sale for an adequate and full consideration in money or money's worth” did not apply. That would require that “the transfer must have been made in good faith, and the price must have been an adequate and full equivalent reducible to a money value.” The Tax Court has stated that a transfer to a FLP may meet this requirement if the record establishes that: “(1) the family limited partnership was formed for a legitimate and significant nontax reason and (2) each transferor received a partnership interest proportionate to the fair market value of the property transferred.” See Estate of Bongard v. Comm'r, 124 T.C. 95 (2005); Estate of Thompson v. Comm'r, 382 F.3d 367 (3d Cir. 2004). To qualify as a legitimate and significant non-tax reason, the reason must be an important one that actually motivated the formation of the partnership from a business point of view, and not merely a theoretical justification.

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