In Estate of Sarah D. Holliday, TC Memo 2016-51TC Memo 2016-51, (the “Estate” and the “Court”, respectively) the Court revisited a common factual pattern in the use of a family limited partnership to reduce estate tax. The use of such partnerships is employed to remove assets from an estate and secure, in connection therewith, a discount in their valuation. In Holliday, the facts led the Court to the conclusion that the Estate lacked a significant nontax reason for a transfer of investment assets by the decedent to a limited partnership and an implied agreement existed that the decedent retained the right to possession or enjoyment of, or the right to the income from, those assets. Therefore, the Estate was required to include the transferred assets in full in the value of the Estate. (See, IRC §2036 and Reg. §20.2036-1(c)(1))
A “bona fide sale for full and adequate consideration” will not cause the transfer to be included in an estate. (IRC §2036(a)). Estate of Bongard, 124 TC 951 (2005) held that the “bona fide sale” rule is satisfied in the context of a transfer to a family limited partnership where the facts reflect 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”.
In the instant case, the decedent, Sarah D. Holliday, formed or caused to be formed, (1) Oak Capital Partners, LP, a limited partnership (“Oak Capital”); (2) OVL Capital Management, LLC, a limited liability company (“OVL Capital”); and (3) the “2006 Holliday Irrevocable Trust” (the “Trust”). Oak Capital’s limited partnership agreement stated that one of its purposes was to provide “a means for members of the Holliday family to acquire interests in the Partnership business and property, and to ensure that the Partnership’s business and property was continued by and closely held by members of the Holliday family.” OVL Capital was created for the primary purpose of being Oak Capital’s general partner.
The decedent funded Oak Capital with nearly $6 million in marketable securities, with a portion of this contribution being made “on behalf of” OVL Capital. The decedent received a 99.9% interest in Oak Capital as a limited partner, and OVL Capital received a 0.1% interest as a general partner. The limited partnership agreement provided that limited partners did not have the right or power to participate in Oak Capital’s business, affairs, or operations. However, the partnership agreement did provide that “to the extent that the General Partner determines that the Partnership has sufficient funds in excess of its current operating needs to make distributions to the Partners, periodic distributions of Distributable Cash shall be made to the Partners on a regular basis according to their respective Partnership Interests.” On the same day as the making of her transfer, Ms. Holliday assigned her interest in OVL Capital to her two sons, Joseph H. Holliday III (Joseph) and H. Douglas Holliday (Douglas) in exchange for $2,960 from each. This price equaled the gross value of 0.1% of Oak Capital’s assets on that date, without a discount or other adjustment.
At the same time, the decedent also transferred 10% of her limited partnership interest in Oak Capital to the 2006 Holliday Irrevocable Trust. Following the transfer, the decedent possessed an 89.9% limited partnership interest in Oak Capital, which she held until her death.
Joseph, Douglas and the decedent’s attorney determined the manner in which the limited partnership’s assets were held by it. At all times before the decedent’s death, on the day she died, and on the alternate valuation date, Oak Capital’s assets consisted solely of investment assets, such as marketable securities, and cash.
Three years after the above planning was put in place, the decedent died. The fair market value of all of the assets owned by Oak Capital, without discount or other adjustment, on July 7, 2009 (the alternate valuation date selected for the Estate) was approximately $4 million. The value of decedent’s interest in Oak Capital was reported on her estate’s tax return as $2.4 million as a result of discounts that were applied to her 89.9% limited partnership interest.
On audit, IRS issued a notice of deficiency determining a $785,019 deficiency in estate tax. The Tax Court upheld the deficiency. It reasoned that the right to distributions under the limited partnership agreement was the retention of possession, enjoyment or right to the income from the investment assets under IRC §2036. Although only one distribution had been made to partners prior to her death, the testimony of Joseph was to the effect that had the decedent required additional distributions they would have been made to the partners. In addition to those salient factors, the Court pointed out that the assets in the limited partnership were not actively managed and were thinly traded.
Although the Estate argued that a fear of lawsuits, the “undue influence of caregivers”, and the preservation of assets all pointed to legitimate and significant nontax reasons for the transfer of assets to the limited partnership, the Court was not persuaded. The decedent had never been sued; she held other assets which could be pursued as well in a lawsuit; she was confined to a nursing home at which she was visited regularly by Douglas on a weekly basis; her assets were managed by her sons; and she acquiesced, without any meaningful input or without any discussion at all, to the decisions of Joseph, Douglas and her attorney in setting up the limited partnership. The Court also cited the facts that the decedent was the sole contributor to the limited partnership; she received 100% of the partnership interests immediately thereafter; and on the same day she assigned her interest in the limited partnership to her sons.
As to the formalities of the operation of the limited partnership, it maintained no significant books and records. There were no partnership meetings or documentation of any meetings. There were no periodic distributions as required by the limited partnership agreement and no compensation was paid to OVL Capital as the general partner. The absence of all of the foregoing factors led the Court to conclude that no legitimate, significant nontax reason existed for the limited partnership’s existence.
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