ESTATES & TRUSTS
TRANSFERS OF PARTNERSHIP INTERESTS AND RETAINED LIFE ESTATES
By Lawrence M. Lipoff, CPA, CEBS, Rosen Seymour Shapss Martin & Company
In Estate of Dorothy Morganson Schauerhamer, Deceased, Karl C. Dean, Personal Representative, Petitioner v. Commissioner of Internal Revenue, Respondent, T.C. Memo. 1997-242 filed on May 28, 1997, an important point regarding estate planning using family limited partnerships was made. Specifically, if a person l) places assets into a family limited partnership and 2) gives away partnership interests but 3) continues to manage the assets exactly as they have been managed in the past, then the entire assets will be included in that person's taxable estate under IRC section 2036(a)(l).
This case has suggested to some practitioners that family limited partnerships are no longer valid estate planning tools. It is hoped that analysis of this case will prove that, properly structured and administered, a family limited partnership remains an important estate planning vehicle.
Prior to her death, the decedent established three substantially identical limited partnerships, one for each of her children. In each limited partnership, the decedent and one of her children were general partners and the decedent was the limited partner. In each case, the decedent as managing partner had "full power to manage and conduct the partnership's business operation in its usual course." After establishing the family limited partnerships, the decedent transferred some of her assets in undivided one-third shares, to the partnerships.
All income was required to be deposited into a partnership account. Without maintaining any records, the decedent deposited partnership income and income from other sources into a joint account held by her and one of her children. These funds were then used, again without records, by the decedent to pay both partnership and personal expenses.
IRC section 2036(a)(1) provides the general rule that "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 an adequate and full consideration in money 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 the possession or enjoyment of, or the right to the income from, the property."
As defined in McNichol's Estate v. Commissioner, 265 F.2d 667, 671 (3d Cir. 1959), aff'g. 29 T.C. 1179 (1958), enjoyment "is synonymous with substantial present economic benefit." Further, even a legally, unenforceable, implied understanding that the transferor would retain economic benefits was found to be
The decedent's children testified that 1) they knew the decedent was transferring funds into a personal account, 2) formation of the partnerships was merely a way to enable decedent to transfer partnership interests, and 3) assets were to be managed as they had been in the past. Additionally, her accountant's claims that partnership funds were not spent for personal benefit could not be corroborated.
Since individuals establishing family limited partnerships for estate planning often continue to manage assets as they have in the past, how does this ruling not "end the game"? Is there a way of allowing the person attempting good planning to reduce gift and estate taxes without losing control of assets?
The answer appears to be that income earned by a partnership is owned by the partnership. Distributions of earnings (which do not have to be required) must be in accordance with the partnership agreement. If the "moneyed individual" requires more money than expected for living expenses, then assets should be retained outside the partnership. Additional cash needs may be satisfied through management fees (albeit subject to self-employment tax) and pro rata distributions to all partners.
Asset protection, one of the major advantages obtained using family limited partnerships, would be compromised if partnership funds were used for personal expenses. Potential creditors would claim that assets were placed into the family limited partnership by a fraudulent conveyance or at least with a badge of fraud. Therefore, they would claim that the transfer should be voided.
Those using family limited partnerships normally would not use this powerful estate planning tool in the manner that Mrs. Schauerhamer did. Such an egregious case should not be viewed as the end of family limited partnerships in estate planning. Rather, since the Tax Court's opinion addressed only the instant fact pattern, the decision should be read narrowly, i.e., family limited partnerships can still stand on their own as successful estate planning vehicles. *
LIFE INSURANCE HELD BY
By Lawrence M. Lipoff, CPA, CEBS, Rosen Seymour Shapss Martin &
In Revenue Ruling 83-147, the IRS discussed the case of Estate of Knipp v. Commissioner, 25 T.C. 153 (1955), acq. in result, 1959-1 C.B. 4 aff'd on another issue 244 F.2d 436 (4th Cir.), cert. denied, 355 U.S. 827 (1957) where insurance proceeds were payable to a partnership. The court stated "the acquisition of the insurance appears to have been nothing more than the purchase of a partnership interest in the ordinary course of business." The revenue ruled "the decedent, in his individual capacity, had no incidents of ownership in the policies and that the insurance proceeds were not includable in the gross estate under the predecessor to IRC section 2042(2). The service acquiesces in the result of Estate of Knipp on the basis that the insurance proceeds were paid to the partnership and inclusion of the proceeds under the predecessor of section 2042 would have resulted in the unwarranted double taxation of a substantial portion of the proceeds, because the decedent's proportionate share of the proceeds of the policy were included in the value of the decedent's partnership interest."
The above revenue ruling is often quoted by those who encourage the use of a partnership to hold life insurance policies as an alternative to an irrevocable life insurance trust. They believe that the use of a family limited partnership provides additional flexibility and control to the insured. The disadvantages that they see with an irrevocable life insurance trust are 1) the irrevocability upon the change of the insured's bounty, 2) the lack of ability to use trust assets for the grantor's benefit, 3) trust law and the fiduciary income tax consequences, 4) the inability of the grantor to serve as trustee, and 5) the problems related to Crummey powers.
The amount of inclusion of the partnership's life insurance proceeds in the gross estate of the insured (assuming he or she is a partner) will be the decedent's proportionate partnership share per section 2033. This will be true if the partnership purchases a new policy per Estate of Headrick, 918 F.2d 1263 (6th Cir. 1930). However, it will not be true if an experienced policy is transferred to the partnership within three years of death. Interestingly, Margaret W. Brown and S. Stacy Eastland, in "The Use of Partnerships in Planning for Life Insurance," Trusts and Estates (April 1995) consider it "advisable for the partnership agreement to negate the implication of any power of a partner to exercise any incident of ownership with respect to partnership owned policies on such partner's life."
For income tax purposes, IRC section 705(a), which is designed to prevent double taxation, will generate an increase in income tax basis upon receipt of
As limited partnership interests are gifted, Private Letter Ruling ("PLR") 9415007 and Technical Advice Memorandum ("TAM") 9131006 allowed the gift to qualify as a present interest for the IRC section 2503(b) annual gift exclusion where the partners have a right to withdraw from the partnership. Therefore, on an annual basis, as the insured contributes funds to pay annual premiums, the grantor can be either provided additional limited partnership interests or a gift will result as a percentage of the proportionate increase in value that the other partners receive.
One of the remaining issues is whether a family limited partnership needs to have a "business purpose" other than holding life insurance. Is it enough to consider life insurance an investment and for the partnership to only hold life insurance? Although PLR 9309021 permitted a partnership with all the restrictions and benefits discussed to hold life insurance, it appears that the IRS may be backing away from this opinion. Possibly if a few stocks are added, [although IRC section 721(b) should be considered regarding potential recognition of gain if a portfolio is
A reason against using a partnership to hold life insurance is that it may be considered a custodial rather than a business activity. This could lead the partnership to be considered by the IRS to be a trust. Still, check-the-box rules may address this concern. Another argument is that the only time that the IRS will follow Knipp is when its entire fact pattern is repeated. Finally, those taking issue with a partnership holding life insurance will argue that in estate planning we want to limit what we leave to chance.
For those times where holding life insurance within a family limited partnership may make sense, this tool should be within a practitioner's toolbox. *
Laurence I. Foster, CPA/PFS
Frank G. Colella, LLM, CPA
Jerome Landau, JD, CPA
James B. McEvoy, CPA
Nathan H. Szerlip, CPA
Lenore J. Jones, CPA
©2009 The New York State Society of CPAs. Legal Notices
Visit the new cpajournal.com.