Estate of Powell v. Commissioner, 148 T.C. No. 18 (May 18, 2017).

Hold on to your seat!  This case has a huge impact on Family Limited Partnership (FLP) planning.  And yes, it creates a new “doughnut hole.”

For the very first time, the Tax Court held that where a decedent owned only limited partnership interests, they are brought back into the donor’s estate under IRC §2036(a)(2).  It also raises the specter of a possible double tax as partnership assets may be included under §2036 and under §2033.

The case has what most estate planning lawyers would call “bad facts.”  It was death bed planning done for a decedent, Nancy Powell, by her son Jeffrey, acting as an agent under a power of attorney.  The estate tax deficiency was $5.88 million.  There was also a gift tax deficiency of $2.96 million. 

Using his power of attorney, decedent’s son transferred $10 million of decedent’s securities to a FLP in exchange for a 99% limited interest.  The two sons contributed notes and receive a 1% general partnership interest.  The general partner had sole discretion to determine the amount and timing of distributions.  The same day, the son, acting as agent, transferred decedent’s 99% limited interest to a charitable lead annuity trust. (One other thing –  the document naming Jeffrey  as agent for his mother Nancy did not include the power to make gifts to anyone other than Nancy’s issue so how could the transfer to the CLAT be valid?)  The remainder in the CLAT was valued with a 25% discount for lack of control and marketability.  This is the source of he gift tax deficiency.

Nancy Powell died 7 days after the day that this transaction was completed by her son.

As if it wasn’t bad enough, the taxpayer in this case didn’t even bother to argue that §2036(a)(2) wasn’t applicable, or to argue that the full consideration exception applied.

The Tax Court held that §2036(a)(2) applied saying that the decedent in conjunction with the other partners could dissolve the partnership (isn’t that always the case?)  and the  decedent through her son Jeffrey who was the general partners and her agent, could control the amount and timing of distributions.  They found the fiduciary duty to be “illusory.”

What ever happened to Byrum?  That was a U.S. Supreme Court case (United States v. Byrum, 408 U.S. 125 (1972)) holding that retaining voting rights to shares of stock in a corporation that decedent had transferred to a trust did not require that the shares be included in his estate under §2036(a)(2)?  Why isn’t that controlling?

For the double tax specter, the court came up with a new concept – the “doughnut hole.”  They held that any consideration received in return for the contribution of securities to the FLP (here the receipt by Nancy of the 99% limited partnership interest)  is subtracted under IRC Section §2043 from the amount included in the gross estate under §2036.

But remember, the discount will be disallowed and the whole value included under 2036(a)(2) for inclusion purposes, but for consideration received, the 99% limited interest received as consideration will be discounted.  Hence, the doughnut hole.

The case can be appealed to the 9th Circuit.  Let’s hope it is.

In Koons v. Commissioner  Case No. 16-10646 (4/27/2017) the 11th Circuit denied the interest deduction for interest on loan to pay estate tax.

Decedent’s revocable trust included a 70% interest in an LLC which had over $200 million in liquid assets.  The estate’s liquid assets were insufficient to pay the estate tax.  The executors refused the offer of a distribution from the LLC to pay taxes and instead, borrowed $10,750,000 from the LLC at 9.5% interest to pay the tax.  No payment was due for 18 years and the principal and interest were scheduled to be repaid in 14 installments between August 2024 and February 2031.  No prepayments were permitted.

The projected interest was $71,419,497 which was taken as a deduction on the estate tax return.

The IRS claimed a $42,771,586.75 estate tax deficiency and a $15,899,463 generation-skipping tax deficiency.

The estate relied on the Estate of Graegin v. Commissioner, 56 T.C.M. (CCH) 387 (1988)  which permitted interest deductions, holding that  “expense incurred to prevent financial loss to an estate resulting forced sale of its assets to pay estate taxes are deductible administration expenses.”

In Koons, the 11th Circuit held that the interest deduction is properly denied if the estate can pay its tax liability using the liquid assets of an entity but elects to obtain a loan from the entity and then repay the loan using those same liquid assets.

A couple of months ago we wrote about the IRS’ s ridiculous position on the estate tax value of this piece of art featuring an "illegal eagle."

The case has been setlled – finally.  A charitable contribution was made to the Museum of Modern Art where it joins others of its ilk.  It spent the last few decades on loan at the Metropllitan Museum of Art.

Eric Gibson writes fo the Wall Street Journal:

"On Wednesday last week, New York’s Museum of Modern Art unveiled its most recent gift, and one of the most significant in its history: Robert Rauschenberg’s "Canyon" (1959). Rauschenberg was among the leading American artists of the post-World War II era, and "Canyon" is a "combine," a kind of large-scale, three-dimensional collage that includes photographs, pieces of wood, a mirror, a pillow and a stuffed bald eagle.

The arrival of "Canyon" at MoMA is the culmination of a five-year absurdist farce—one tinged more by Kafka than Feydeau—that involved the IRS, the U.S. Fish and Wildlife Service and the heirs of art dealer Ileana Sonnabend. It might have been laughable, except that the stakes were so high. "

Read the rest of his article.

P.S.  For you arty types – check out this blogpost and compare "Canyon" to Rembrant’s "Rape of Ganymede."

Read Charles Rubin’s blogpost:  click here

The U.S. District Court for the Southern District of New York "found the DOMA provisions unconstitutional under the lower “rational basis” standard which requires only that a law have a rational basis for its classifications to withstand an equal protection clause challenge. The court determined that the purposed bases of protection of the institution of marriage, protection of childrearing and procreation, consistentcy and uniformity of federal benefits, and conserving the public fisc were not rationally served by the DOMA provisions. The court thus ordered that the refund be paid."

Windsor v. U.S., 109 AFTR 2d ¶ 2012-870 (DC N.Y. 6/6/2012)

2010 is the year with no federal estate tax. George Steinbrenner died in July 2010. His family will be saving about $500 million in estate tax and won’t have to sell the Yankees to pay the tax. Forbes says 5 billionaires died so far in 2010, and the tax their estates would have owed totals $8.7 billion.

Under the tax cut legislation, the estate tax exemption increased to $3.5 million and then in 2010 the estate tax was repealed for the year. If nothing changes, the estate tax will be back January 1, 2011 with a $1 million exemption.

The year with no estate tax was the year to "throw mamma from the train." This year’s estate planning techniques included one-way tickets to Switzerland where euthanasia is legal. Congressman Richard E. Neal, quoted in the New York Times when asked about the expiration or the estate tax in 2010 said, "If you’re at the checkout counter, you might want to expedite things."

Three states – Oregon, Washington and Montana – allow versions of the practice of euthanasia or assisted suicide. Oregon’s law took effect in 1997, and Washington enacted a similar one in 2009. Montana’s Supreme Court recently ruled that nothing in the state constitution prohibited doctors aiding patients with dying, but voters haven’t yet specifically authorized it. Some countries, such as Switzerland and the Netherlands, have long allowed physicians to aid patients in dying. But only Switzerland extends this benefit to foreigners.

In a recent news story in Wyoming, Representative Cynthia Lummis claimed some of her Wyoming constituents are so worried about the reinstatement of federal estate taxes that they plan to discontinue dialysis and other life-extending medical treatments so they can die before Dec. 31. She didn’t name names, but gave the example of a rancher on dialysis seriously considering termination of treatment to let the end come and, thus, escape the estate tax due to come back two months hence.

This news article generated page after page of comments on the internet. Many took the approach that if a person has enough money to have to pay federal estate tax, they ought to be able to pay a professional to minimize or even eliminate the transfer taxes at death. True, good planning can minimize the impact of taxes, but it can’t eliminate them.

Some commentators advocated stealth gifts to the family, or selling the farm to the kids for one hundred dollars. These approaches don’t work. These are do-it-yourself techniques that just create problems. The IRS is anything but naive. A transfer of a $5 million dollar ranch in a $100 dollar sale is really a $4.999900 million gift. Doing this could actually result in more tax due, not to mention penalties and interest. The gift tax exclusion is only $1 million, but the estate tax exclusion might be as much as $5 million next year.

All this said, one enlightened responder to the posting, an estate planning lawyer named Emil Blatz quoted a study showing this "hurry up and die" mentality to be a recurring phenomenon. He quotes research stating that "academic researchers have known for years that death rates are influenced by major changes in estate-tax law. A 2003 paper published in the prestigious Review of Economics and Statistics looked at 13 major estate-tax changes in the U.S. – following the creation of the tax in 1916 – and found they had a small but statistically significant effect on death rates. "Among those wealthy enough to be affected by the changes, the chance of dying increased slightly in the two weeks before rates went up and decreased in the two weeks after an estate-tax cut, a phenomenon the authors have dubbed death elasticity."

As one elderly gentleman put it, with sardonic humor, "In 2010 I’m not going to linger too long at the top of any stairways."

David Kocieniewski reports for The New York Times: (click here for full article)

"A Texas pipeline tycoon who died two months ago may become the first American billionaire allowed to pass his fortune to his children and grandchildren tax-free, The New York Times’s David Kocieniewski reports.

Dan L. Duncan, a soft-spoken farm boy who started with $10,000 and two propane trucks, and built a network of natural gas processing plants and pipelines that made him the richest person in Houston, died in late March of a brain hemorrhage at 77.

Had his life ended three months earlier, Mr. Duncan’s riches — Forbes magazine estimated his worth at $9 billion, ranking him as the 74th wealthiest in the world — would have been subject to a federal tax of at least 45 percent. If he had lived past Jan. 1, 2011, the rate would be even higher — 55 percent.

Instead, because Congress allowed the tax to lapse for one year and gave all estates a free pass in 2010, Mr. Duncan’s four children and four grandchildren stand to collect billions that in any other year would have gone to the Treasury."

BUT DON’T FORGET ABOUT CARRY-OVER BASISNew Carry-Over Basis Rules for 2010

The fact that there is no estate tax is only half of the story.  The heirs will have to take over the decedent’s basis in all assets and income tax liabilities will be huge on liquidation of assets.  Its not the free pass it appears to be at first blush.

Here we are four months into 2010 and there has been no change to the gift and estate tax law.  Most observers were surprised that a patch to continue the law as it stood in 2009 was not enacted.  Now there is talk of such a patch or even a new law that would accomplish it retroactively.  But the first truly rich American has died, a multi-billionaire who was number 74 on the world wealth rankings.  His estate has plenty of money to spend fighting any retroactive tax law as well as a lot of money to be saved if it prevails.  But what if nothing happens?

As a refresher, if the estate tax law of 2001 is allowed to expire then everyone’s estate can pass $1,000,000 free of federal estate tax. Above that, the estate is taxed on a rising bracket scheme until the top bracket of 55 percent is reached.  There is a surtax on estates over $10 million until the benefits of bracketing are gone and the estate is taxed at a flat 55 percent.  Also, the state tax paid is allowed as a credit, not just a deduction.  There is a table that shows what the IRS will accept as state death tax credit. It starts after $60 thousand and moves up in brackets until it reaches 16 percent.  This is the ultimate in revenue sharing because what you pay to your state is reduced dollar for dollar from your federal estate tax.  It was phased out in the four years following 2001 but would reappear if the current law is allowed to reach “sunset”.

Every state used that table as part of or all of their estate tax assessment.  It was called the state estate tax, or the slack tax, or the pickup tax.  When it was phased out, some states (the “time machine” states) adjusted their laws to levy tax as if the IRS law in effect before 2001 was still in effect.  Others, the “philosophical” group, just shrugged, apparently saying, “Easy come, easy go.”  Pennsylvania tried the “time machine” approach, but bracketed tax violates the state constitution, so it begrudgingly had to join the “philosophical” group.  While the state estate tax was always unconstitutional in Pennsylvania, it was never challenged in court because no one was injured by it (except maybe the IRS) and so there was no cause of action.  When credit for it started vanishing from the IRS credit list, a cause of action was created and thus the trip to the back of the “philosophical” line for Pennsylvania.

If sunset occurs, the states are ready to enjoy the benefit again.  Since U.S. Senators and Congressmen are well aware of their state’s financial problems, it seems they all have a motive to allow the “sun to set”.  But the federal government needs money too, so wouldn’t this cause an income problem for the U.S. Treasury?

The answer is yes and no, but mostly no.  Consider what Pennsylvania and the IRS collect on an estate under the 2009 regime and again under the 2011 sunset rules.  Assume the decedent is the second of a couple to die. There is almost never any tax for the first to die thanks to the unlimited spousal exemptions in both the federal and state tax law.  Assume all the estate will go to children or parents, for whom the state inheritance rate is 4.5 percent.

With an estate of $6 million, both the state and the US would end up with about twice as much income.  At $10 million, the state does about 2.4 times better, while the U.S. still does better but only by a factor of 1.37.  At $30 million, the factors are 3.16 and 1.05.  At $40 million, the factors are 3.26 and 1.01.  At a net estate of $44,337,107, the factors are 3.29 and 1.0.  The IRS actually takes in the same dollar amount.  Above this level, the state factor keeps getting better, but with a limit, while the IRS factor drops below 1.0.  At $250 million, the factors are 3.51 and 0.92.  At $1 billion, the factors are not much different, being 3.54 and 0.91.

Both taxing authorities improve their income in the ten million dollar range.  The state continues to improve until it collects about three and a half times more in the billion dollar range.  The IRS drops to break even at about $44 million and collects less than before above that amount but never dropping below 90 percent of what it had collected.  Estates pay more, since 55 percent is more than 45 percent.  But, more of the revenue stays in the state, which is a motive that could leave us seeing the sun set in 2011.