Tax Cases

Transfer of Partnership Interest Was Not Immediate Gift (TC)
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The tax court was faced with whether gifts petitioners made of limited partnership interests to their adult children during 2000, 2001, and 2002 qualified as annual exclusions pursuant to section 2503(b). The court found that they did not. On September 11, 1997, petitioners formed Price Investments Limited Partnership (the partnership) under Nebraska law. When the partnership was formed, Price Management Corp., a Nebraska corporation, was its 1-percent general partner; the Walter M. Price Revocable Trust and the Sandra K. Price Revocable Trust were each 49.5-percent limited partners. Mr. Price was president of Price Management Corp., and Mr. and Ms. Price, through revocable trusts, held the shares in Price Management Corp. The limited partnership agreement (the agreement) stated that the partnership’s primary purpose was to achieve a reasonable rate of return on a long-term basis with respect to its investments. Shares were transferred to the children over time. The agreement generally prevented any partner from withdrawing capital contributions or transferring a partner’s interest to a non-partner. In ruling against the petitioners the court concluded that the transfers were gifts of a future interest because contingencies stood between the donees and their receipt of economic value for the transferred interest.
Price v. Comm. of Internal Revenue, T.C. Memo 2010-2; 2010 Tax Ct. Memo LEXIS 2 (1/4/2010)

Survivorship Clause Not Sufficient to Avoid Estate Tax (Tax Court)
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This issue was whether the petitioner could move for leave to amend the petition to allege the affirmative defense of equitable recoupment. In Estate of Lee v. Commissioner, T.C. Memo. 2007-371 (Estate of Lee I), the Tax court had held that the decedent’s estate was not entitled to claim a marital deduction under section 2056 because Kwang Lee (decedent) died after his wife, Kyoung Lee (Ms. Lee). The estates of decedent and Ms. Lee filed their respective Federal estate tax returns as if decedent had predeceased Ms. Lee. Then Ms. Lee’s estate reported that most of decedent’s wealth passed to her as decedent’s surviving spouse and was taxable to her estate. Petitioner argued that the court’s holding in Estate of Lee I meant that (1) Ms. Lee’s estate should not have included any of decedent’s wealth; (2) inclusion of decedent’s wealth in Ms. Lee’s estate resulted in a $356,336.33 overpayment of her estate’s Federal estate tax; and (3) decedent’s estate may equitably recoup Ms. Lee’s estate’s claimed overpayment as a reduction of any deficiency determined in this case. The ruled against the petitioner because the IRS still had to rule on its first request for a refund making the application of the equitable relief inapplicable. On the issue of the survivorship clause, on June 4, 2007, respondent moved the Court for partial summary judgment on the issue of whether decedent’s estate may benefit from the marital deduction when decedent died after Ms. Lee. In Estate of Lee I, the court held that decedent’s intent that he be treated as predeceasing Ms. Lee was insufficient to qualify his estate for the marital deduction under section 2056 because Ms. Lee actually had to survive decedent to qualify as a “surviving spouse” for purposes of that section. Accordingly, the marital deduction sought by decedent’s estate was denied.
Estate of Lee v. Comm. of Internal Revenue, T.C. Memo 2009-303; 2009 Tax Ct. Memo LEXIS 308 (December 23, 2009)

Gift Tax Paid by Recipient of Gift Includable in Decedent’s Estate Under IRC 2035(b) (Tax Court)
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Husband (H) and wife (D) established a revocable inter vivos trust. After H’s death the portion of the trust representing H’s one-half of the community property was allocated to a residual trust in which D received an income interest for life. A qualified terminable interest property (QTIP) election was made under sec. 2056(b)(7) on H’s estate tax return for the property passing to the residual trust, thereby allowing H’s estate to claim a marital deduction for the full value of the QTIP. During D’s lifetime the trust was divided into two trusts. D made gifts of her qualifying income interests in both trusts, which in turn triggered deemed transfers of the QTIP remainder under sec. 2519. Recipients of the QTIP paid gift taxes. D died within 3 years of the transfers. R determined that the amounts of gift tax paid by the recipients of the QTIP remainder are includable in D’s gross estate under sec. 2035(b), I.R.C. Held: The amounts of gift tax paid by the recipients of the QTIP remainder are includable in D’s gross estate under sec. 2035(b).
Estate of Morgens v. Comm. of Internal Revenue, 2009 U.S. Tax Ct. LEXIS 38; 133 T.C. No. 17 (12/21/2009)

Conflict of law rules determine domicile of marriage for purposes of determining whether community property rules applied (Tax Court)
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The decedent and his wife were born in and married in Uganda while it was a British province; they were citizens of the United Kingdom. They were exiled when Idi Amin ordered the expulsion of Ugandans of Asian descent. They fled to Belgium in 1972 and resided there through the time of decedent’s death in 2002. At the time of his death, decedent owned 250,000 shares of stock in Citigroup valued at $11,790,000; on the alternative valuation date the stock was worth $8,312,500. A tax is imposed on the estate of a nonresident decedent with property in the United States and stock in a U.S. corporation is property situated in the United States. Decedent’s wife argued, though, only one-half of the stock was subject to taxation because the stock was community property under Belgium law. The IRS took the position that all of the stock was included in the decedent’s estate because, under United Kingdom law, it was not community property. The court found that the marriage was created under United Kingdom law. The decisive question was whether the forced exile of decedent and his wife from Uganda altered the location of the matrimonial domicile and changed the nature of the marital property. Two theories arguably applied in resolving the question: the doctrine of immutability and the doctrine of mutability. Under the first, the answer turns on the law of the parties’ domicile at the time of the marriage; under the second, it turns on the law of domicile at the time of death. The court found that under United Kingdom law, which was found to apply, the doctrine of immutability applied. The property was not community property at the time of marriage and did not become so by reason of their move to Belgium; absent some change by the parties, they entered into an implied contract at the time of marriage which continued thereafter. They could have taken steps under Belgium law to change the character of their property rights, but they failed to do so before decedent’s death. Further, an addition to tax was assessed because the estate filed its return after the deadline. The estate argued that legal complexities regarding ownership of the stock and the practical steps associated with forming a qualified domestic trust justified the delay. The additional tax was sustained because alleged reliance on counsel and legal complexities did not establish reasonable cause for delay.
Estate of Charania v. Commissioner, 133 T.C. No. 7, No. 16367-07 (9/14/09)

Fancy estate tax plan defeated because decedent used assets as collateral (Tax court)
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Decedent wanted to reduce his estate tax liability. He established two family limited partnerships (FLP) and four trusts as part of his estate plan. Decedent was the general partner of each FLP and two of the trusts (one for each of his children) were limited partners of each FLP. Decedent transferred stock into the first FLP and transferred stock and his interest in four LLCs into the second FLP. The method of conveyance was complex, including multiple transfers and a SCIN; we do not recite the details here. After decedent’s death, the service argued that the value of the property in the FLPs was included in the decedent’s estate and assessed a $6,192,938 deficiency. The service based its initial argument on Section 2036, arguing that decedent retained the present economic benefit of the FLP assets under an implied agreement because he used those assets to secure and collateralize his pre- and post-death financial obligations. The estate countered, arguing there was no implied agreement giving decedent an economic benefit; they argued the transaction was structured as an investment in the best interests of the FLP; it was approved by the trustees with decedent guarantying repayment, plus interest. The court found for petitioners with respect to the LLC interests transferred to the second FLP (they were indirect gifts to his children), but found for the IRS regarding the stock because the stock transferred to the FLP was used by decedent to discharge legal obligations and to secure his personal loans. Further, the court was unconvinced that the pledge to secure personal debts was a business decision made at arm’s length. The estate then argued that the stock transfers nonetheless fell within the section 2036(a) exception for bona fide sales. However, to prevail, Petitioners were required to show a legitimate and significant non-tax reason for creating the FLPs. Petitioners presented three non-tax reasons: (1) to provide for his children; (2) to prevent the sale of any stock in the family company; and (3) to centralize management of family wealth. Each reason was rejected because the facts failed to support a non-tax reason for creating the FLPs. Related gift tax deficiencies connected with establishment of the FLPs are not discussed in this summary.
Estate of Malkin v. Commissioner, T.C. Memo 2009-212 (9/16/09)

Gift tax applies to LLC interest, not underlying property value (Tax Court)
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After Suzanne Pierre received a $10,000,000 gift from a wealthy friend, she decided to do something for her son and granddaughter. Still, because she wanted to minimize taxes, she hired a planner. She organized a single-member LLC and placed $4.25 million in the LLC. Pierre did not check-the-box to elect corporate treatment of the LLC, so it was reported as a pass-through entity. Twelve days after forming the LLC, Pierre transferred her LLC interests to two trusts, one for her son and one for her granddaughter. She accomplished this with a combination of gifts (a 9.5% interest in the LLC to each trust) and the sale of her remaining LLC interests for promissory notes. An appraiser valued the LLC, discounted it thirty percent from the value of the underlying assets. The gifts were reported on Form 709 using the discounted values. The IRS disagreed, arguing that the gift value could not be discounted and should reflect the full value of the assets in the LLC because, under its check-the-box regulations, a pass-through LLC is disregarded for purposes of gift tax liability. The IRS issued deficiencies of $1,130,216.11 and $24,969.19 on Petitioner’s gift tax and generation-skipping transfer tax, respectively. In reviewing the transaction, the court found that State law fixes property rights and federal law merely defines the tax consequences of transferring those rights. Since no interest in the underlying assets was transferred, gift tax liability is determined based on the value of what was passed, which was the LLC interest. The court found that while the check-the-box regulations may determine how an LLC is classified for tax purposes, they do not federalize property rights so as to define the interest transferred by a donor. Thus, except where Congress has changed the valuation rules, the Commission cannot by regulation overrule the historical gift tax valuation regime. In this case, that means the gift tax applies to the value of the LLC interests rather than the value of underlying assets.
Pierre v. Commissioner, No. 753-07, 2009 U.S. Tax Ct. LEXIS 21; 133 T.C. No. 2 (August 24, 2009)