I COMMUNITYFOUNDATION

r. I COMMUNITYFOUNDATION of Central Florida • 0. • . es A 1.. "Family Limited * - Partnerships Alive and Kicking" Special Guest David Pratt, Esq. Supported B: IN•. , ,..,,,,r:. AMENcAN .FINANUAL Walialg --.. Mil EFTA01126625 UPDATE ON USE OF FAMILY LIMITED PARTNERSHIPS AND DISCOUNT PLANNING DAVID PRATT, ESQ. JENNIFER E. ZAKIN, ESQ. Proskauer Rose LLP 2255 Glades Road, Suite 340W Boca Raton. FL 33431 Phone: Fax: E-mail: ©COPYRIGHT 2009 DAVID PRATT, ESQ. AND JENNIFER E. ZAKIN, ESQ. ALL RIGHTS RESERVED EFTA01126626 EFTA01126627 TABLE OF CONTENTS Page I. Introduction 1 The Statute and the Regulations 2 "IRS Friendly" Section 2036 Cases 4 A. Estate of Schauerhamer v. Commissioner 4 B. Estate of Reichardt v. Commissioner 6 C. Estate of Harper v. Commissioner 7 D. Estate of Thompson v. Commissioner 10 E. Estate of Strangi v. Commissioner 16 F. Estate of Abraham v. Commissioner 25 G. Estate of Hillgren v. Commissioner 30 H. Estate of Bongard v. Commissioner 32 I Estate of Bigelow v. Commissioner 35 J. Estate of Korby v. Commissioner 38 K. Estate of Disbrow v. Commissioner 42 L. Estate of Rosen v. Commissioner 46 M. Estate of Erickson v. Commissioner 51 N. Estate of Gore v. Commissioner 55 O. Estate of Rector v. Commissioner 58 P. Estate of Hurford v. Commissioner 61 Q. Estate of Miller v. Commissioner 67 R. Estate of Malkin v. Commissioner 70 S. Estate of Jorgensen v. Commissioner 73 IV. The "Taxpayer Friendly.' Cases 76 A. Church v. U.S 76 B. Estate of Stone v. Commissioner 78 C. Kimbell v. U.S 85 D. Estate of Schutt v. Commissioner 88 E. Estate of Mirowski v. Commissioner 90 F. Keller v. U.S 100 G. Estate of Murphy v. U.S 103 V. The "Service's Best Friend" — Byrum 105 A. United States v. Byrum 105 EFTA01126628 VI. Determining the Discount Adjustments 108 A. Lappo v. Commissioner 108 B. Peracchio v. Comissioner 109 C. Estate of Kelley v. Comissioner 111 D. Succession of Charles T. McCord v. Comissioner 112 E. Astleford v. Comissioner 116 VII. Indirect Gifts/Step Transaction 119 A. Shepherd v. Commissioner 119 B. Senda v. Commissioner 121 C. Holman v. Commissioner 123 D. Gross v. Commissioner 127 E. Heckerman et ux v. U.S. 129 F. Linton v. U.S. 131 G. Pierre v. Commissioner 133 VIII. The Future of Valuation Discounts 134 IX. IRS Appeals Settlement Guidelines for FLPs 136 X. Gift and Estate Tax Returns 138 XI. Fiduciary Duty to Establish FLP 139 XII. H.R. 436: Certain Estate Tax Relief Act of 2009 140 XIII. Checklists to Avoid Section 2036 142 A. Practitioner's "Formation" Checklist 142 B. Client's "Operational" Checklist 145 C. Bona Fide Sale for Adequate and Full Consideration Checklist 149 D. Checklist to Avoid Section 2036(a)(2) 150 XIV. Exhibits 152 ii EFTA01126629 UPDATE ON USE OF FAMILY LIMITED PARTNERSHIPS AND DISCOUNT PLANNING I. INTRODUCTION. A. Over the past several years, the Internal Revenue Service (the "IRS") has used various legal theories to combat the application of discounts in family limited partnership ("FLP") planning. B. From Sections 2703 and 2704 of the Internal Revenue Code of 1986, as amended (the "Code"), to lack of a business purpose, to substance over form, to gifts on formation, to step transaction theories, the IRS generally has been unsuccessful. C. The IRS has a very strong weapon in its arsenal — Section 2036. The IRS has successfully argued, in nineteen separate cases, that Section 2036 can cause estate tax inclusion of the assets owned by the FLP. D. And a new theory seems to be developing — the indirect gift/step transaction theory. The IRS has used this theory in seven separate cases to challenge the taxpayer. E. Estate planners continue to use FLPs in order to achieve valuation discounts. While FLPs certainly provide a vast array of nontax benefits, such as asset protection, divorce protection and consolidation of assets, to name a few, many clients establish the FLP in order to obtain discounts on the value of their assets for transfer tax purposes. 1. Query: How many of your clients would have established an FLP if no valuation discounts were available? F. Because FLP planning has become more challenging, practitioners who recommend and implement the FLP must be cognizant of the 2036 issues and advise their clients in such a manner that would make it extremely difficult, if not impossible, for the IRS to attack the FLP using a Section 2036 argument. Practitioners now also have to be particularly concerned about the formation of the partnership and subsequent transfers of partnership interests so that they are not captured under the "indirect gift/step transaction" theory. G. This outline discusses the following: 1. Section 2036, the regulations promulgated thereunder and, perhaps most importantly, the cases in which the IRS has successfully used Section 2036 to include partnership assets in a decedent's gross estate. The outline also discusses the seven FLP cases in which the IRS was not successful using Section 2036 (Church Stone Kimbell Schutt Mirowski Keller and Murphy) and Byrum, the Supreme Court case which the EFTA01126630 IRS may cite as authority in order to assert that the assets owned by the limited partnership should be included in a decedent's estate under Section 2036(a)(2). 2. The cases which question the applicable discounts applied to transfers of general and limited partnership interests. 3. The cases addressing the indirect gifUstep transaction theory. 4. The recent proposals regarding the limitations on the discounting of value of an entity interest for lack of marketability and/or control when such interests, such as interests in an FLP and/or limited liability company, are transferred. 5. A couple of years ago, the IRS issued appeals settlement guidelines for FLPs and family limited liability companies. These guidelines are effective beginning October 20, 2006; the issues, positions of the taxpayers and IRS and the guidelines are discussed in this outline and are attached as an exhibit. 6. Questions on Federal gift and estate tax returns, Forms 709 and 706, respectively, have made it easier for the IRS to audit family limited partnerships. 7. A recent case has addressed whether a corporate trustee had a fiduciary duty to transfer marketable securities held in a marital trust to a family limited partnership. 8. On January 9, 2009, the House of Representatives issued H.R. 436, which is known as the Certain Estate Tax Relief Act of 2009 (the "2009 Act"). Section 4 of the 2009 Act addresses valuation rules for certain transfers of non business assets and the limitation on minority discounts. 9. Four checklists have also been provided, one concerning formation of the FLP, one concerning operations of the FLP, one regarding the bona fide sale for adequate and full consideration exception to the application of Section 2036 and one which discusses how to avoid a Section 2036(a)(2) argument. 10. Lastly, at the end of this outline, there are three exhibits. The first exhibit is a compilation of questions used by the IRS in Section 2036 audits. The second exhibit is the IRS appeals settlement guidelines for FLPs. The last exhibit is a copy of H.R. 436, which is the House of Representatives Bill dealing with valuation discounts. II. THE STATUTE AND THE REGULATIONS. A. Code Section 2036(a) contains the general rule for "transfers with a retained life estate" as follows: The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for adequate and full consideration in money 2 EFTA01126631 or money's worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death— (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom. B. Treasury Regulations Section 20.2036-1, transfers with retained life estate, is instructive. It states, in relevant part, the following: 1. A decedent's gross estate includes under Section 2036 the value of any interest in property transferred by the decedent, whether in trust or otherwise, except to the extent that the transfer was for an adequate and full consideration in money or money's worth, if the decedent retained or reserved (1) for his life, or (2) for any period not ascertainable without reference to his death, or (3) for any period which does not in fact end before his death— (a) The use, possession, right to the income, or other enjoyment of the transferred property, or (b) the right, either alone or in conjunction with any other person or persons, to designate the person or persons who shall possess or enjoy the transferred property or its income. Treas. Reg. § 20.2036-1(a). (i) If the decedent retained or reserved an interest or right with respect to all of the property transferred by him, the amount to be included in his gross estate under Section 2036 is the value of the entire property, less only the value of any outstanding income interest which is not subject to the decedent's interest or right and which is actually being enjoyed by another person at the time of the decedent's death. Treas. Reg. § 20.2036-1(a). (ii) An interest or right is treated as having been retained or reserved if at the time of the transfer there was an understanding, express or implied, that the interest or right would later be conferred. Treas. Reg. § 20.2036-1(a). 2. The phrase "use, possession, right to the income, or other enjoyment of the transferred property" is considered as having been retained by or reserved to the decedent to the extent that the use, possession, right to the income, or other enjoyment is to be applied ... or otherwise for his pecuniary benefit. Treas. Reg. § 20.2036-I(b)(2). 3. The phrase "right . . . to designate the person or persons who shall possess or enjoy the transferred property or the income therefrom" includes a reserved power to 3 EFTA01126632 designate the person or persons to receive the income from the transferred property, or to possess or enjoy nonincome-producing property, during the decedent's life or during any other period described in paragraph (a) of [Treasury Regulation Section 20.2036-1]. (a) It is immaterial (i) whether the power was exercisable alone or only in conjunction with another person or persons, whether or not having an adverse interest; and (ii) in what capacity the power was exercisable by the decedent or by another person or persons in conjunction with the decedent. (b) The phrase does not apply to a power held solely by a person other than the decedent. However, if the decedent reserved the unrestricted power to remove or discharge a trustee at any time and appoint himself as trustee, the decedent is considered as having the powers of the trustee. Treas. Reg. § 20.2036-1(b)(3). (i) Query: Could this regulation apply to a limited partner's right to remove a general partner and replace such general partner without restriction? III. "IRS FRIENDLY" SECTION 2036 CASES. A. Estate of Schauerhamer v. Commissioner T.C. Memo 1997-242. 1. Formation Facts. (a) (b) 1990. Decedent was diagnosed with colon cancer in November of 1990. Decedent met with estate planning attorney in early December of (c) On December 31, 1990, decedent, along with her three children and their spouses, met with estate planning attorney and implemented the following plan: (i) Three partnership agreements were executed and certificates of limited partnership were filed with the state (Utah). (ii) Each of decedent's children was a 4% general partner; decedent was a 1% general partner and a 95% limited partner. The partnership agreement stated that each child would contribute $4 (for his or her 4% general partnership interest) and decedent would contribute $95 (for her 1% general partnership interest and 95% limited partnership interest). (iii) Decedent was the managing partner of each partnership. 4 EFTA01126633 (iv) Decedent contributed various assets, in undivided one- third interests, to the three partnerships. It appears that the assets contributed were "business" type of assets. There is no indication that the children made any contribution of assets to the partnerships. (v) Decedent made thirty-three gifts of limited partnership interests, each with a value of a "$10,000 interest in the partnership." (d) On January I, 1991, decedent made identical gifts of limited partnership interests. 2. Operational Facts. (a) Each partnership's initial capital was deposited into a partnership bank account. (b) The partnership agreements required that all income from the partnership be deposited into a partnership account; decedent deposited such income and income from other sources into an account held jointly between her and her son's wife. (c) Decedent did not maintain any records to account separately for the partnership and non partnership funds. (d) Decedent utilized the account as her personal checking account and paid personal and partnership expenses from the account. (e) Decedent transferred additional assets to the partnerships on November 5, 1991 (thirty-eight days prior to her death). Again, there is no indication that the children made any contribution of assets to the partnerships. 3. Section 2036 applied for following reasons. (a) partners. The facts established that an implied agreement existed among the (b) Decedent owned the assets subsequently transferred to the partnerships and collected the income the assets generated. (c) In violation of the partnership agreements, decedent deposited the partnership income into an account she used as a personal checking account and commingled it with income from other sources. The Court stated that Is]uch deposits of income from transferred property into a personal account are highly indicative of 'possession or enjoyment.' (d) Decedent managed the assets and income generated by the assets exactly as they had been managed in the past. The Court stated that "[w]here a decedent's relationship to transferred assets remains the same after as it was EFTA01126634 before the transfer, Section 2036(a)(1) requires that the value of the assets be included in the decedent's gross estate." B. Estate of Reichardt v. Commissioner, 114 T.C. 144 (2000). 1. Formation Facts. (a) Decedent, after just being diagnosed with terminal cancer, and his son met with certified public accountant on June 5, 1993. (b) On June 17, 1993, decedent executed his revocable trust and family limited partnership agreement. Decedent and his children were the co- trustees of the revocable trust; it appears that each trustee had independent authority to act on behalf of the trust. (c) The revocable trust was the limited partnership's only general partner. (d) The certificate of limited partnership was filed on June 21, 1993. (e) Decedent transferred all of his property (except for his car, personal effects and a nominal amount of cash) to the partnership. (1) Decedent was the beneficiary and co-executor (with his children) of his wife's estate. He signed deeds individually and on behalf of his wife's estate which conveyed his and the estate's interest in various pieces of real estate, including his residence, to his revocable trust. He also signed deeds as trustee conveying such real estate to the limited partnership. (g) Within the next two months, decedent transferred to the trust, and then to the partnership, investment accounts, a note receivable and some cash (approximately $33,000). (i) At least $20,540 of the cash was attributable to rental income from the real property he had previously contributed to the partnership. (h) A portion of the real estate contributed to the partnership was owned by decedent's wife's estate; his wife was the beneficiary of her late uncle's estate. When a portion of the real estate was sold, the proceeds were paid to decedent's wife's estate; the money was then contributed directly into the partnership's bank account. 2. Operational Facts. (a) Decedent controlled and managed, or allowed the co-owners to control and manage, the partnership assets in the same manner both before and after he transferred them to the partnership. 6 EFTA01126635 (b) Decedent used the same brokers and asset managers before and after he transferred the property to the partnership. (c) Decedent was the sole individual who signed partnership checks and documents. (d) While some of the real property owned by decedent was conveyed to the partnership, the co-owners of such property continued to manage such property. (e) Decedent's accountant made adjusting entries in the partnership's accounting records in an attempt to classify items of income and expense between decedent and the partnership. There was no evidence that the partnership or decedent transferred any funds to the other as a result of the adjusting entries. (f) While decedent continued to live in the residence contributed to the partnership, he did not pay any rent to the partnership. 3. Section 2036 applied for the following reasons. (a) Decedent did not "curtail" his enjoyment of the transferred property after he formed the partnership. (b) Nothing changed except legal title. Decedent managed the trust which managed the partnership. He was the only trustee to sign the articles of limited partnership, the deeds, the transfer of lien, and any document which could be executed by one trustee on behalf of the trust. He was the only trustee to open brokerage accounts or sign partnership checks. He did not open any accounts for the trust. (c) Decedent commingled partnership and personal funds. He deposited some partnership income in his personal account and he used the partnership's checking account as his personal account. (d) Decedent lived in the residence before and after he contributed it to the partnership, and he did not pay rent to the partnership for his right to live in the residence. (e) Decedent transferred nearly all of his assets to the trust and partnership. The Court stated that "[t]his suggests that decedent had an implied agreement with his children that he could continue to use those assets." C. Estate of Harper v. Commissioner T.C. Memo 2002-121. 1. Formation Facts. (a) Decedent was an attorney specializing in entertainment law. However, he had experience in the areas of tax, and wills and trusts law. 7 EFTA01126636 (b) Decedent was diagnosed with prostate cancer in 1983 and rectum cancer in 1989. (c) Decedent was the sole trustee of his revocable trust; his two children were the successor trustees. (d) It is not exactly clear when decedent decided to form a limited partnership. However, it was formed in 1994 with an effective date of January 1, 1994 stated in the preamble of the partnership agreement. There was also a provision in the partnership agreement indicating that the partnership shall commence upon the date a certificate of limited partnership is filed with the Secretary of State. The certificate of limited partnership was filed with the Secretary of State on June 14, 1994. (e) From June 17'h through June 20th of 1994, decedent was hospitalized. The medical records indicate that he was "well known to have metastatic colonic carcinoma and prostatic carcinoma." (0 Decedent's revocable trust was named as the initial 99% limited partner. His two children were named as the general partners; his son held a .6% interest and his daughter held a .4% interest. His son was also designated to serve as the managing partner of the partnership. (g) The partnership agreement requires the decedent's revocable trust to contribute the "Portfolio" and the general partners are not obligated to make any capital contribution to the partnership. (h) The "Portfolio" was not defined in the partnership agreement. However, there was no dispute that it consisted of securities held in various investment accounts, shares in a company known as "Rockefeller Center Properties, Inc." and a note receivable. (i) Decedent contributed the "Portfolio" to the partnership. The value of the assets contributed to the partnership represented approximately 94% of the decedent's assets. Decedent did not contribute his personal effects, a checking account, his automobile and his residence. (j) There were conflicting provisions regarding distributions from the partnership. One provision gave the managing general partner the "sole and absolute" discretion to make distributions to the partners. Another provision required distributions of "Ordinary Net Cash Flow" to be distributed to the partners based on their percentage interests in the partnership. (k) Decedent gifted 60% of his limited partnership interests (owned by his revocable trust) to his children in an assignment with an effective date of July 1, 1994. The gifted limited partnership interests were designated as "Class B" limited partnership interests. The partnership agreement was amended so that decedent's remaining (39%) limited partnership interests (owned by his revocable 8 EFTA01126637 trust) became a "Class A" limited partnership interest which was entitled to a "Guaranteed Payment" of "4.25% annually of its Capital Account Balance on the Effective Date." (1) Decedent commenced the funding of the partnership on July 26, 1994; it continued for approximately four months. (m) In a letter dated September 29, 1994, decedent instructed one of the brokerage firms to sell all the securities in his revocable trust's investment account and use the proceeds to repurchase the same securities in a partnership account. (n) On September 23, 1994, decedent's son, as general partner, opened a checking account in the name of the partnership. A deposit of interest was made into the account and various distributions were made to the partners. (o) In January of 1995, decedent entered hospice care in Oregon; he died on February 1, 1995. 2. Operational Facts. (a) A certified public accountant was engaged after Decedent's death to prepare financial books and tax returns for the partnership. (b) The accountant established a general ledger for the partnership to categorize and account for partnership transactions as of June 14, 1994, the date of the entity's formation. Capital accounts and ledger accounts were established for partners to reflect partnership distributions. (c) The accountant established an account named "Receivable from Trust." The account was created to reflect amounts received by decedent's revocable trust after the partnership's formation; such amounts should have been received by the partnership, but were not so received because of the delay in transferring assets to the partnership and opening the partnership account. The "Receivable from Trust" account balance was treated as a distribution to the decedent's revocable trust; no funds were transferred between the revocable trust and partnership. 3. Section 2036 applied for the following reasons. (a) Circumstances were very similar to Reichardt and Schauerhamer. (b) Decedent commingled partnership and personal funds. The partnership account was opened more than three (3) months after the partnership was formed. Prior to the opening of the account, partnership income was deposited into decedent's revocable trust account resulting in an unavoidable commingling of funds. EFTA01126638 (c) Lack of respect of the entity as a true business enterprise. The Court focused on hiring of the accountant only after decedent's death, and the delay in opening the partnership account and the transferring of assets to the partnership. The Court stated that the "partners had little concern for establishing any precise demarcation between partnership and other funds during decedent's life." (d) Decedent transferred the majority of his assets to the Partnership. Thus, the distribution of partnership funds indicated an implied understanding that the partnership would "not curtail decedent's ability to enjoy the economic benefit of assets contributed." (e) Distributions from the partnership to the decedent's revocable trust were found to be contemporaneously used for decedent's personal expenses. (0 Partnership was viewed as an alternate vehicle for decedent to provide for his children at death (i.e., an estate plan). The Court focused on the testamentary characteristics of the partnership scheme: Decedent made all decisions regarding creation and structure of the partnership, decedent continued to be the principal economic beneficiary and there was little change in the portfolio composition. Any practical effect of the partnership was not meant to occur until after decedent's death. (g) The Court also took note of decedent's advanced age, serious health conditions and experience as an attorney. D. Estate of Thompson v. Commissioner, T.C. Memo 2002-246. 1. Formation Facts. (a) Decedent executed a durable power of attorney in favor of his children, Robert Thompson ("Robert") and Betsy Turner ("Betsy"). (b) In an effort to reduce their father's estate tax exposure, Robert and Betsy consulted with various advisors regarding the establishment of two (2) FLPs on behalf of decedent, and his two children and their families — the Turner Partnership ("Turner FLP") and the Thompson Partnership ("Thompson FLP"). The financial advisor worked for the company which was the licensee for Fortress Financial Group, Inc. Such group was also involved with the Strangi family in Strangi. (c) The Turner FLP was established under Pennsylvania law for the benefit of Betsy and her husband, George Turner ("Mr. Turner"), and their family. The Turner Corporation was the corporate general partner owning a 1.06% interest in the Turner FLP. Decedent was a 95.4% limited partner and Mr. Turner was a 3.54% limited partner. Regarding the Turner Corporation, decedent owned 490 shares, Betsy and Mr. Turner each received 245 shares and an unrelated tax- exempt entity received the remaining 20 shares. 10 EFTA01126639 (d) The Turner FLP and Turner Corporation were formed on April 21, 1993 and were funded in the same year. The Turner FLP was funded as follows: Decedent contributed marketable securities with an approximate value of $1,286,000 in addition to notes receivable from Betsy's children in the amount of $125,000. Mr. Turner contributed $1,000 in cash and real property located in Vermont with a value of $49,000. The Turner Corporation issued a non-interest bearing note in favor of decedent for its interest in the Turner FLP. (e) The Thompson FLP was established under Colorado law for the benefit of Robert and his family. The Thompson Corporation was the corporate general partner owning a 1.01% interest. Decedent was a 62.27% limited partner and Robert was a 36.72% limited partner. Regarding the Thompson Corporation, decedent and Robert each owned 490 shares and Robert H. Thompson, an unrelated party, received the remaining 20 shares. (f) Similar to the Turner entities, the Thompson FLP and Thompson Corporation were formed on April 21, 1993 and were funded in the same year. The Thompson FLP was funded as follows: Decedent contributed marketable securities with an approximate value of $1,118,500 in addition to notes receivable from Robert's family members in the amount of $293,000. Robert contributed his interest in mutual funds with an approximate value of $372,000 and his Norwood ranch which was appraised at $460,000. (g) In summary, the decedent had contributed $2.5 million in assets to the two partnerships and had retained $153,000 in personal assets. (h) At the time of the transfers, decedent had an annual income of $14,000 from two annuities and social security, and had annual expenses of $57,202. (i) At the time of the transfers, decedent had an actuarial life expectancy of 4.1 years. 2. Operational Facts. (a) Before forming the entities, decedent and his children agreed that decedent "would be taken care of financially." (b) Before and after the formation of the FLPs, Betsy and Robert consulted with the financial advisors regarding decedent's accessibility to assets in the FLPs for purposes of continuing his practice of gift giving around Christmas time to various family members. Based upon such consultations, distributions were made from the FLPs in 1993, 1994 and 1995 to decedent in order for him to continue such gifting practice. (c) Decedent contributed the majority of his assets to the FLPs. Thus, distributions from the FLPs were made for purposes of satisfying decedent's personal expenses. 11 EFTA01126640 (d) Regarding the Turner FLP, investment strategies for assets did not change upon the transfer of assets to the partnerships and the same advisors were employed. Account activity was "low," trading activity of the account recognized as not even "moderately" traded. (e) Turner FLP owned insurance policies on lives of Betsy and Mr. Turner and paid annual premiums on such policies. (t) Turner family engaged in a real estate venture involving Lewisville Properties, a modular home construction venture. Turner FLP financed the purchase and construction costs through a margin loan made on the Turner FLP account. The property was eventually sold for a loss of $60,000 and Phoebe Turner received a commission of $9,120 on the sale. (g) Betsy and Mr. Turner assigned their interest in a real estate partnership to the Turner FLP; however, after such assignment the partnership interest remained titled in the name of Betsy and Mr. Turner rather than the Turner FLP. (h) Turner FLP engaged in various loans to the Turner children and grandchildren. Monthly interest payments owed on the notes were often late or not paid. No enforcement action was taken regarding the repayment of the interest. No loans were made to anyone outside of family members. (i) During the funding process, Robert contributed his Colorado ranch to the Thompson FLP and entered a lease for such property paying rent of $12,000 per year. Robert maintained the ranch in the same manner before and after the contribution (i.e., raised and trained mules on the ranch). Any income from the sale of the mules went to Robert, rather than the partnership. However, the Thompson FLP claimed losses in various years from the operation of the ranch. (j) After decedent's death, distributions were made from the FLPs to fund specific bequests set forth in decedent's will. Additionally, the FLPs provided funds to pay for the decedent's estate taxes. 3. Section 2036 applied for the following reasons. (a) The Court recognized that an "implied agreement" existed whereby decedent would retain the benefit and enjoyment of the assets transferred to the FLPs during his lifetime. (b) Decedent transferred the majority of his assets to the FLPs retaining an insufficient amount for his support. Thus, a distribution from the FLPs would be necessary, and was made, to satisfy decedent's personal expenses. The Court reasoned that transfers from the FLPs to decedent can only be explained if decedent had at least an "implied understanding that his children 12 EFTA01126641 would agree to his requests for money from the assets he contributed to the partnerships, and that they would do so for as long as he lived." (c) Assets were "formally" transferred from decedent to the FLPs; however, there was no meaningful change in the composition of the asset portfolio nor in decedent's relationship to the assets. Decedent was still the "principal economic beneficiary" of the contributed property after such contribution and the Court recognized that only a "legal title" change occurred with respect to the property transferred. (d) Property transferred to the FLPs was merely "recycled," meaning that the form of ownership of the property had changed (from individual ownership to entity ownership), but decedent's relationship to such assets had not. (e) Decedent's family members also engaged in this "recycling" of their assets through the FLPs. The assets contributed to the FLPs were not pooled with the other partner's contributions. Specifically, although the partner transferred property to the FLP, he or she continued to receive the sole benefit of income generated by such property after the contribution rather than having income generated by the FLP property disbursed to the partners in accordance with their partnership percentages. 4. Turner v. Commissioner 382 F.3d 367 (3niCir. 2004). (a) The taxpayer in Thompson appealed the Tax Court's decision to the United States Court of Appeals for the Third Circuit; such Court affirmed the decision of the Tax Court, discussed above. (b) If there is an express or implied agreement at the time of the transfer that the transferor will retain lifetime possession or enjoyment of, or right to income from, the transferred property, such property will be included in the transferor's gross estate under Section 2036(a)(1) of the Code. The Court, after reviewing the evidence, determined that there was no clear error in the Tax Court's finding of an implied agreement between the decedent and his family whereby the decedent would retain the enjoyment of the transferred property during his lifetime. The decedent transferred the majority of his assets to the partnership and did not retain sufficient assets to support himself. Thus, it was likely that the decedent would need funds from the partnership for such purpose and the record indicates that his family recognized this fact and would distribute assets to him as necessary. Although the formal title of the assets changed from individual ownership to ownership in the name of the partnership, decedent's relationship to the assets before and after the transfer did not change. (c) The Court recognized that Section 2036 of the Code provides an exception for any inter vivos transfer that is a "bona fide sale for adequate and full consideration in money or money's worth." 13 EFTA01126642 (d) The Court referred to Harper and stated that the bona fide sale exception to an inter vivos transfer will be denied when there exists nothing but a circuitous "recycling" of value and when the transaction does not appear to be motivated primarily by legitimate business concerns. The Court concluded that there was no transfer for consideration under Section 2036. Although the partnerships did conduct some economic activity, it was not enough to support any valid, functioning business enterprise. Indeed, the estate conceded that the primary objective in forming the partnership was not to engage in or acquire active trades or businesses. (e) The Court referred to the specific activities conducted on behalf of the partnerships to conclude that no valid business was conducted. The Court addressed the fact that loans made on behalf of the Turner FLP were intra-family loans only, with interest payments being late or not paid. The Court agreed with the Tax Court that the loans were a way to use the decedent's money as a source of financing the needs of family members, rather than a way to use the money for a business purpose. Regarding the Thompson FLP, the Court addressed that the only active operations involved the Norwood ranch. However, such ranch was not operated as an income producing business either before or after the property was contributed to the partnership. Income generated with respect to the property went to Robert Thompson, the contributor, rather than to the partnership. The Court referred to Norwood ranch as a "putative business arrangement" which "amounted to no more than a contrivance and did not constitute the type of legitimate business operations that might provide a substantive nontax benefit for transferring assets to the Thompson FLP." (t) Although Turner FLP's investment in the Lewisville Properties ($186,000) seemed to qualify as a legitimate business transaction, it was not enough to outweigh the testamentary nature of the transfer to the Turner FLP and the operation of such entity. (g) The Court also addressed the form of the assets transferred to the partnerships, which was predominantly marketable securities. The Court recognized that a nontax benefit for establishing the partnerships is questionable if the partnerships hold an untraded portfolio of securities with no ongoing business operations. The Court distinguished the facts in Thompson from the facts in Church, Stone and Kimbell. (h) The Court concluded that the transfers to the partnerships did not constitute "bona fide sales" to qualify for the exception under Section 2036, although for a different reason than suggested by the Commissioner. The Commissioner argued there was no bona fide sale because a bona fide sale requires an arm's length bargain, and there can be no such bargain when one party stands on both sides of the transaction (i.e., as transferor and as limited partner). However, the Court stated that neither the Code nor the Treasury Regulations define a "bona fide" sale to include an "arm's length transaction" between unrelated parties. The Court recognized, however, that "mischief that may arise 14 EFTA01126643 in the family estate planning context" and that such mischief can be monitored by heightened scrutiny of intra-family transfers and does not require prohibition to all family limited partnerships. (i) Although an "arm's length transaction" is not a requirement, the transfer must be made in good faith. The Court addressed the fact that a good faith transfer to a partnership must have a benefit other than the estate tax benefits. Regardless of whether all of the partnership formalities are followed, the transaction cannot be entered solely for the purpose of saving estate taxes with no business purpose. (j) In short, because the partnerships did not conduct any legitimate business operations nor provide the decedent with any nontax benefits, the exception to Section 2036 could not be met and inclusion in the gross estate under such Section was required. (k) Judge Greenberg's concurring opinion, as joined by Judge Rosenn. (i) Judge Greenberg had some additional thoughts with respect to the issue of whether the transfers qualified as transfers for the "adequate and full consideration in money or money's worth" exception. In this case, because the transfers were not for money, the exception could only apply if the transfers were for property that can be regarded as being for "money's worth." Judge Greenberg opined that the conclusion is clear that if a discount is justified, in a valuation sense, the decedent could not have receive adequate and full consideration for his transfers in terms of "money's worth." (ii) Judge Greenberg also addressed the estate's argument, which is not addressed in the majority opinion, that the decedent did not make a gift for gift tax purposes upon the formation of the partnerships and, therefore, there must have been full consideration for his transfers for purposes of Section 2036. The Judge agreed that there were no gifts made upon formation of the partnerships, but concluded that the estate's argument that the gift tax and estate tax are in pan materia is immaterial to a determination, as such relationship did not change the fact that decedent retained the right to enjoyment of the property and did not receive adequate and full consideration for it in money's worth. (iii) Judge Greenberg also stated that the logic of the case should not be applied too broadly. He imagined many partnerships existed where the partner died after contributing assets to the partnership and, therefore, made a transfer that could be included under Section 2036(a). He stressed that the Court cannot hold in all circumstances that Section 2036(a) could apply requiring the valuation of the decedent's interest at death be made by looking at the assets within the partnership, rather than his or her respective interest, thus disregarding the partnership's existence 15 EFTA01126644 for estate tax valuation purposes. Judge Greenberg does not want the court's reasoning in Thompson to apply routinely in commercial circumstances, although he does not think it would be. E. Estate of Strangi v. Commissioner T.C. Memo 2003-145. 1. Procedural Posture. (a) On January 17, 1996, a Form 706, United Stated Estate (and Generation -Skipping Transfer) Tax Return, was filed on behalf of decedent's estate. The value of decedent's partnership interest was reported as $6,560,730 and a value of $25,551 was reported for decedent's stock in the general partner of the partnership. (b) In a statutory notice dated December 1, 1998, the IRS determined a deficiency in federal estate tax and, alternatively, a deficiency in federal gift tax, resulting from an increase in the value of decedent's interest in the partnership to $10,947,343 (a deficiency in the amount of $4,386,613) and an increase in the value of decedent's interest in the general partner of the partnership to $53,560 (a deficiency in the amount of $29,009). (c) Strangi's first appearance before the Tax Court was in response to the above deficiencies. Prior to trial, the IRS, by motion, attempted to add Section 2036 to their list of legal theories which would deny the discount. The Tax Court denied the motion on the ground of untimeliness and ruled in favor of the taxpayer on all the other issues. See Estate of Strangi v. Commissioner 115 T.C. 478 (2000). The Tax Court holding with respect to the issues other than 2036 are not addressed herein; they were all favorable with respect to the taxpayer. (i) The IRS appealed to the Court of Appeals for the Fifth Circuit. The Court of Appeals affirmed on all issues other than the question of whether the IRS was timely with respect to raising the Section 2036 argument. The Fifth Circuit reversed the Tax Court's denial of leave to amend and remanded with either of two (2) instructions, the pertinent of which was that the Tax Court reverse its denial of the IRS's motion, permit an amendment to answer and consider the 2036 issue. See Gulig v. Commissioner, 293 F.3d 279 (5th Cir. 2002) aff g in part and rev'g in part Strangi v. Commissioner, 115 T.0 478 (2000). (ii) On July 15, 2005 the Fifth Circuit affirmed the Tax Court decision under Section 2036(a) that the decedent retained enjoyment of the assets transferred to SFLP and that such assets were properly included in the decedent's estate. Strangi v. Commissioner, 417 F.3d 468 (5th Cir. 2005). The Fifth Circuit decision is discussed below. 16 EFTA01126645 2. Formation Facts. (a) On July 19, 1988, Albert Strangi ("decedent") executed an extremely broad durable power of attorney in favor of Michael J. Gulig, his son- in-law. (b) In May of 1993, decedent had surgery that removed a cancerous mass from his back. In the summer of 1993, decedent was diagnosed with supranuclear palsy, a brain disorder that would gradually reduce his ability to speak, walk and swallow. In September of 1993, decedent had prostate surgery. After such time, decedent's son-in-law took over the management of decedent's affairs pursuant to the durable power of attorney. (c) On August 12, 1994, decedent's son-in-law, acting as decedent's agent through the durable power of attorney, formed the Strangi Family Limited Partnership ("SFLP") and its corporate general partner, Stranco, Inc. ("Stranco"). Decedent's son-in-law was a practicing attorney who had done a substantial amount of estate planning. Decedent's son-in-law had attended a seminar given by the Fortress Financial Group, Inc. the day before he formed the entities. Indeed, all documents relating to the formation of the entities were furnished by Fortress. (d) Decedent purchased 47% of the shares of the corporate general partner for cash; decedent's four children purchased the remaining 53% of the shares of the corporate general partner for cash. The corporate general partner contributed the cash to the limited partnership in exchange for a 1% general partnership interest. 98% of decedent's property, the majority of which was cash and securities, was contributed to the partnership in exchange for a 99% limited partnership interest. Decedent also contributed his personal residence, accrued interest and dividends, insurance policies, an annuity, receivables and partnership interests to the partnership. One of decedent's children loaned her three siblings the money to purchase the shares in the corporate general partner. (e) Each of the four (4) children gifted a .25% interest in Stranco to a public charity, which became a 1% shareholder in the corporation. (0 Decedent and his four (4) children served as the board of directors of the corporate general partner. One of the children was the president. Pursuant to a management agreement, the corporate general partner employed decedent's son-in-law to manage the affairs of SFLP and Stranco. (g) Decedent died of cancer on October 14, 1994 at the age of 81; it is unclear whether he was terminal at the time the partnership was established. However, in August of 1994, decedent's son-in-law believed decedent had about 12 to 18 months to live and decedent's spouse expected decedent to survive for a period of 2 years. Additionally, from September of 1993 until his death on October 14, 1994, decedent required 24-hour home health care. 17 EFTA01126646 3. Operational Facts. (a) Stranco never had formal meetings. (b) After decedent died, various distributions were made from SFLP to decedent's children (totaling $2,662,000) and corresponding and proportionate distributions were made to Stranco. Distributions to the children were characterized as distributions to the estate (as the children were beneficiaries of the estate). (c) After decedent died, SFLP also paid for decedent's funeral expenses, estate administration expenses, related debts of the decedent, and a specific bequest in decedent's will to decedent's sister. (d) SFLP paid for the back surgery of decedent's housekeeper who injured her back while working for decedent. (e) In July of 1995, a distribution of $3,187,000 was made from SFLP to the decedent's estate to satisfy decedent's federal and state estate taxes. SFLP also advanced funds to decedent's estate to post bonds with the IRS and the state of Texas in connection with the review of decedent's estate tax returns. (f) SFLP accrued rent on the residence occupied by decedent and reported the rental income on its 1994 income tax return. The accrued amount was paid in 1997. (g) The primary account held by SFLP was divided into four (4) separate accounts for decedent's children. Each child then had control over a proportionate share of the partnership's assets. (10 SFLP extended lines of credit to decedent's children. 4. Section 2036(a)(1) applied for the following reasons. (a) The partnership agreement provided the corporate general partner with the sole discretion to determine when distributions from the partnership would be made. The shareholders of the general partner, pursuant to the executed management agreement, provided decedent's son-in-law with the authority to make such distributions and act on behalf of the partnership and corporation. (b) The court determined that the property must be included in decedent's estate under Section 2036(a)(1) based solely on the "right to income criterion without looking for an implied benefit to satisfy the "possession" or "enjoyment" criteria of the Section. There were no restrictions evident in the governing entity documents which would have prevented the decedent, through his son-in-law pursuant to the durable power of attorney, from receiving income from the partnership and corporation. 18 EFTA01126647 (c) The court also determined that an implied agreement existed whereby decedent retained possession and enjoyment of the assets transferred to the partnership. The reasoning of prior caselaw such as Reichardt, Thompson and Schauerhamer were found to control here. The Tax Court concluded that the decedent "fundamentally" retained the same relationship to his assets before and after the establishment of the partnership. (d) The court acknowledged that, in contrast to prior cases, the participants proceeded such that "the proverbial Ts were dotted and the Ts were crossed." However, such measures only gave SFLP and Stranco sufficient substance to be recognized as legal entities in the context of valuation. They do not preclude implicit retention by decedent of economic benefit from the transferred property for purposes of Section 2036(a)(1). (e) The decedent transferred approximately 98% of his assets, including his personal residence, to the partnership. The court weighed the decedent's "liquefied" assets versus "liquefiable" assets in determining that an implied understanding existed whereby the partnership and corporation would be a primary source of financial support for decedent. The court found it unreasonable to expect the decedent to rely on the sale of assets for his daily living needs. (1) The court also stated that a feature "highly probative" under Section 2036(a)(1) was the fact that the decedent's per