Estate of Powell v. Commissioner: FLP Planning Lessons
1. Discussion. In Powell, the Tax Court, in a reviewed decision, determined that the assets that had been transferred to a family limited partnership (“FLP”) were included in the decedent’s gross estate in a fact pattern reminiscent of prior bad fact FLP cases.
a. $10M of cash and marketable securities that had been held in the taxpayer’s revocable trust. The assets were transferred into an FLP formed by the taxpayer’s sons.
b. The sons were the general partners, and the only other partners, in the FLP. Their interests were received for the contribution of unsecured promissory notes.
c. The transactions were consummated about a week before the taxpayer’s death, and when the taxpayer was incapacitated, in a clear case of deathbed planning.
d. The same day as the FLP was formed the son, acting under a durable power of attorney, transferred the taxpayers 99% LP interest into a charitable lead annuity trust (“CLAT”). That power of attorney, however, only permitted gifts to descendants (not a CLT), and in amounts not more than the annual exclusion (well under the amount give). The annuity was to be paid to the taxpayer’s private foundation. At the end of the CLAT term the remainder would pass to trusts for each of the sons. The transfer reflected a 25% valuation discount and was supported by an independent appraisal.
e. A gift tax return was filed reporting the gift to the CLAT.
f. The IRS argued that the assets were included in the taxpayer’s estate under IRC Sec. 2036(a)(1) and (2) on the basis of an implied agreement entitling the taxpayer to possession and enjoyment of the assets during her lifetime. The IRS also argued that the decedent, acting with her sons, could dissolve the FLP and thus designate the persons who would possess and enjoy the property that had been transferred to the FLP. The taxpayer’s estate conceded to this argument.
g. The Tax Court held that the assets were includible in the taxpayer’s gross estate under IRC Sec. 2036(a)(2). The Tax Court also provided a new approach to avoid duplication of the value of the FLP interest and the underlying assets when estate tax inclusion occurs under IRC Section 2036(a). The gross estate should include two components of value: (1) the value of the decedent’s FLP interests under IRC Sec. 2033. This value should reflect any valuation discounts taken; and (2) the value of the assets transferred to the FLP reduced by the value of the FLP interest the taxpayer received.
h. The Tax Court indicated that state law fiduciary duties would be disregarded in family situations as illusory.
2. Reference. 148 T.C. No. 18 (May 18, 2017).
3. Planning Considerations.
a. Since Powell was clearly a bad fact FLP case, it provides another laundry list of bad facts practitioners should avoid in planning for FLPs. Considering the high estate tax exemption and possibility of repeal perhaps Powell also provides a checklist of how to undermine FLP discounts if that proves advantageous. However, the bad facts in Powell would also likely seem to undermine the asset protection the FLP would otherwise afford as well.
b. The compressed time frame in Powell is not a new issue. As but one example, in the Kite case the transactions there were implemented in three steps over a planned three-day period in March 2001, so close in time that the issue of all being an integrated transaction was raised. On March 28, 2001, QTIP trust assets consisting of the 99% interest in a limited partnership were distributed to taxpayer’s revocable trust. On March 29, 2001, another partnership contributed additional assets. On March 30, 2001, taxpayer’s revocable trust sold its entire interest to taxpayer’s children for the deferred unsecured private annuities.
c. It is quite recently that practitioners have seen other bad fact FLP cases. Three of these are discussed below. It would seem with the long list of bad fact FLP cases that planners would not repeat some of the same mistakes.
d. Estate of Purdue v. Comr., TC Memo 2015-249. The IRS challenged the transfer of assets to the FLP as not meeting the adequate and full consideration requirement. They also challenged gifts of FLP interests as not meeting the preset interest requirement. Marketable securities were owned in separate accounts managed by different firms. There was also an interest in a net leased rental property. The business purpose argued by the taxpayers was consolidation of assets and aggregation to meet qualified investor requirements. In Powell, marketable securities were transferred to an FLP with seemingly little consideration of a business purpose. The Court held for the taxpayers noting no commingling of personal and entity assets, assets were properly transferred to the entity, the entity formalities were adhered to, taxpayers were in good health when the entity was created.
e. Holliday v. Comr., TC Memo 2016-51. The steps critical to the planning were all performed in a single day – contributing cash and marketable securities to the entity followed by gifts of entity interests. This was also an issue in Powell with the funding of the FLP and gift of FLP interest to the CLAT in the same day. The Holliday Court was not swayed by the taxpayer’s justifications of business purposes for the transaction. Asset protection motives were dismissed as the taxpayer lived in a nursing home and the court did not see those as realistic. Similarly in Powell the business purposes were not enunciated or supported. The entity in Holliday did not keep books and records. The formalities of the entity were ignored in making distributions, etc.
f. Estate of Beyer v. Comr., TC Memo 2016-183. Assets were included in the decedent’s estate under IRC Sec. 2036(a)(1) even assets purportedly sold to a grantor trust. The taxpayers violated several of the cardinal FLP “no-no’s.” Formalities were ignored, distributions were made to the wrong people, tax returns were filed listing incorrect owners (but amended to correct), and more. There was no bona fide sale exception as the purported business purposes were not recognized. In Beyer the Court did not accept the alleged significant non-tax reasons for creation of entity. In Beyer the taxpayers claimed that the decedent wanted to keep primary investments intact. Stock was in trust they could have addressed that goal in that context. In Beyer the taxpayer could have named the nephew as investment adviser or co-trustee. The taxpayer failed to carry burden of proof to create credible evidence. In Powell the sons were general partners of the FLP but had already controlled their mother’s assets as agents under her power of attorney.
g. It also seems that many practitioners continue to treat durable powers of attorney as boilerplate. Many seem to “throw in” powers and health proxies to the preparation of wills and revocable trusts as almost a free add-in. Powers of attorney should be planned and crafted with no less care than wills and revocable trusts. Had those involved in planning for Powell (before the incapacity, when documents were initially completed) for an estate of that size extra care in permitting a more tailored less “standard” gift provision would have been advisable (although it would not likely have saved the day with the bad facts that followed). In general, with the increasing emphasis on later life planning, practitioners should all endeavor to educate clients that powers of attorney are essential documents that deserve more attention.
h. If a durable power of attorney is used for tax planning after the principal is incapacitated, the gift power should be sufficiently broad to allow for the desired level of gifting. Standard provisions generally are limited to descendants and annual exclusion gifts. Consider the following: “Principal authorizes Agent to make gifts of up to Principal’s remaining federal gift tax exemption amount so long as such gifts are made to an irrevocable trust which Principal created, Trust-Name, Trust-Date.” This approach might have addressed one issue in Powell in that the actions under the durable power would not have exceeded the amount or gone beyond the class of beneficiaries. Many clients are uncomfortable with an open ended gift provision but if the gifts are limited to a maximum dollar amount or the remaining exemption, and the donee is limited to irrevocable trusts reflecting the client’s wishes that might suffice to assuage client concerns.
i. When evaluating gift provisions under durable powers of attorney and revocable trusts consider the current high estate tax exemption and the possibility of repeal, practitioners should revisit all gift provisions in powers of attorney and revocable trusts. Many might no longer be justified. Finally, if significant gifting is contemplated, consider naming an independent agent who can consummate the gifts thereby minimizing the risks of the gift power causing inclusion in the estate of an interested agent.
j. For any entities created or existing a significant business purpose should exist and be corroborated generally. If transfers are contemplated this independent business purpose is essential to qualify for the bona fide sale exception to IRC Sec. 2036(a). But perhaps the key lesson from Powell is clients should be educated as to the importance of regular review meetings so planning can be addressed in advance and with sufficient time to address formalities and practical sequencing. It is difficult, if not impossible, to properly address planning at the last minute as in Powell.
k. Practitioners needed another bad fact FLP case? How is it that practitioners have not yet learned the lessons of bad FLP cases? After professional fees of trying anything was it really worth the risk? Why do clients not understand the critical nature of periodic reviews by a collaborative team? Had the estate tax issue faced by Powell been addressed in advanced, in a more collaborative manner, surely some tax benefits would have been realized, and the costs of the litigation avoided.
l. There is also another question that the Powell cases raises. The myriad of negative FLP cases has done nothing to quash the comfort level of practitioners using FLPs in planning. The perspective is to plan better and more carefully than the bad FLP case patterns. Why has that mindset not replicated itself more in the context of the use of self-settled trusts? While certainly there are differences in the analysis, is there no comparability?