On February 3, 2010, the Tax Court released its decision in Estate of Shurtz v. Commissioner.
This case is interesting for a number of reasons. First, even though it involves a family limited partnership, the case is not about the estate taking substantial discounts. In fact, the word “discount” is not even mentioned in the decision. Here, the IRS tried to argue that under section 2036, the full value of all the underlying assets contributed by the Decedent to the partnership should be included in the Decedent’s gross estate, and not the value of her proportionate, possibly non-discounted partnership interest. Additionally, this case involves the value of the partnership interest after the death of the first spouse, in which the entirety of the estate was transferred to either a credit shelter trust or a marital deduction trust, resulting in no tax due.
I’m a bit surprised that the IRS took this pure 2036 non-discount case to trial, as the evidence of a non-tax business purpose is so clear.
Background
The Decedent, Charlene B. Shurtz, was an heir to a very wealthy and religious family, the Barges (not related to El or Chico De Barge). The Barge family’s assets primarily consisted of timberland in Mississippi. In 1993, at least 14 members of the Barge family owned separate undivided interests as tenants in common in thousands of acres of timberland, either outright or in trust. Even if the estate tax didn’t exist, any competent business or probate attorney would advise the family that this type of ownership is a serious mistake, fraught with risks. The property could be subject to the creditors of individual owners, and joint management of property owned by so many people is burdensome and unwieldy. Based on an attorney’s (correct) advice, they established Barge Timberlands, L.P., a limited partnership, to operate the family timber business. The Decedent owned a 16 percent interest in Timberlands LP and also 1/3 of the shares of the corporation that served as the general partner.
The Timberland partnership agreement provided that the partnership would distribute 40 percent of its income each year to the partners, so that the partners would have funds to pay taxes on their distributive share of flow-through partnership income.
The Decedent, along with her siblings and fellow partners, were still concerned that individual family members could — due to Mississippi “Jackpot Justice” — lose their interest in the Timberland Partnership and control of the family business. The family was advised that if each of them contributed their Timberland Partnership interests to a separate partnership, that would provide better creditor protection because distributions could be locked into the new partnership, and a creditor would not be entitled to receive anything but a charging order. In addition, the Decedent wanted to make gifts of the family timberland business to her children.
The Doulos Family Limited Partnership
She and her husband formed a new limited partnership, Doulos LP, in November 1996. The purpose of Doulos LP was to reduce the estate, provide asset protection, provide for heirs, and — in this deeply religious and charitable family — “provide for the Lord’s work.” The Doulos LP agreement had language restricting an outsider from owning an interest, language that was presumably absent from the Timberland LP agreement. The Decedent also still owned 748.2 acres of timberland outright and in her name only, not contributed to the Timberland LP.
Before the Doulos Partnership could be established, there was a problem: the Decedent owned 100% of everything that was going to be transferred to the partnership. She first transferred a 6.6% interest in her 748.2 acres to her husband, and then the two of them contributed their interests in the timberland, plus her interest in Timberland LP, to the Doulos Partnership.
Over the next four years, she made a total of 26 gifts of .4 percent limited partnership interests to her children and to trusts for her grandchildren. Each gift was valued at $19,700 or less. The Doulos Partnership maintained accurate capital accounts for each of its members and filed a Form 1065 every year. The entire family actively participated in managing both the Timberland LP and the Doulos LP, holding annual meetings and consulting family members before any major decisions were made.
The Decedent’s Estate
Upon Mrs. Shurtz’s death, her gross estate was valued at $8,768,055.03, with $7,674,143.03 going to trusts qualifying for the marital deduction and $345,800 going to a credit shelter trust. Her Form 706 was filed eight months late, but as there was no tax due because of the use of credit shelter and marital deduction trusts, her lawyers were not particularly concerned.
The IRS argued that the full value of all assets contributed by the Decedent to the Doulos Partnership should be included in her estate under section 2036 — not the value of the partnership interest itself — because the IRS contended she retained control, use, and benefit of the assets within the meaning of sections 2036 and 2035 (some of the transfers were within three years of her death).
The Court’s Decision
The decision does not state what evidence the IRS used to argue that assets should be included under 2036, probably because there was not much there. The Court pointed out that section 2036 causes property to be included in a decedent’s gross estate if three conditions are met:
- The decedent made an inter vivos transfer of property;
- The decedent’s transfer was not a bona fide sale for full and adequate consideration; and
- The decedent retained the possession or enjoyment of, or the right to the income from, the property, or the right to designate the persons who shall possess or enjoy the property or income therefrom.
The Court, citing Estate of Bongard and Estate of Bigelow, noted that the bona fide sale exception is met where the record establishes the existence of a legitimate and significant nontax reason for creating the family limited partnership, and the transferors received partnership interests proportionate to the value of the property transferred. The objective evidence must indicate that the nontax reason was a significant factor motivating the partnership’s creation.
The facts here supplied several non-tax reasons for establishing the Doulos Partnership, including asset protection and centralized management. These were not deathbed transfers, and the Decedent maintained sufficient assets outside the partnership to support herself. She also received a proportionate partnership interest in exchange for her contribution — as did her husband, each receiving interests valued in proportion to what they separately contributed.
Because the transfers to the partnership were a bona fide sale for fair and adequate consideration, they were not includable in her gross estate under section 2036.
Takeaway
The IRS is still actively pursuing family limited partnerships, discounts or not. Partnerships that are shams will not survive scrutiny. But as long as taxpayers have legitimate non-tax business purposes for establishing the partnership and maintain adequate records in both formation and operation, section 2036 should not apply to the transfers.