Whenever we assist our clients in establishing sophisticated estate plans we always advise them to “follow the rules.” Failure to do so may result in a disappointing tax result. That is precisely what happened in the recent case of Estate of Harper v. Commissioner, where the Tax Court agreed with the IRS’s inclusion of the value of assets contributed to a partnership in a donor’s gross estate.
The donor, Morton Harper (“Harper”), created a family limited partnership, at least partially to provide a means by which his assets would be protected from the claims of his daughter’s creditors after his death. Harper gave each of this children general partnership interests that aggregated one percent of the total partnership interests, and Harper retained a 99% limited partnership interest. Later, Harper gave his children 60% of the limited partnership interests, and amended the partnership to create a retained preferred interest that was entitled to an annual guaranteed payment, paid quarterly, equal to 4.25% of the capital account balance.
The agreement was signed “as of the 1st day of January 1994.” Harper transferred substantially all of his investment assets to the partnership, including a portfolio of brokerage accounts and a promissory note. It took over four months to complete the transfer of most of the assets to the partnership. The agreement gave Harper’s son, as managing general partner, authority to determine the timing and amounts of partnership distributions, in his “sole and absolute discretion.”
The IRS argued that the full fair market value of the assets contributed to the partnership should be included in Harper’s estate, rather than the partnership interest owned at death, which could have been discounted because of the existence of the partnership. The Tax Court agreed with the IRS’s argument that the decedent retained the economic benefit of the partnership assets, because he and his children had not strictly followed the terms of the partnership agreement. The Tax Court noted, in particular, that: (1) the partnership had not immediately established a separate bank account, as required by the agreement, having deposited funds in Harper’s personal account for more than three months after the formation of the partnership, resulting in a commingling of partnership and personal assets; (2) the delay in obtaining a separate account and in completing the transfer of assets to the partnership resulted from a relatively lax attitude on the part of the managing general partner, reflecting a perceived view that the partnership should not materially change Harper’s situation during the remainder of his life; and (3) the distributions of the guaranteed payment were often made monthly, rather that quarterly, as required by the partnership agreement.
The Tax Court stated the total facts showed “a consistent pattern of acting in response to particular needs of decedent or his estate” and an “indifference by those involved toward the formal structure of the partnership arrangement and, as a corollary, toward the degree of separation that the Agreement facially purports to establish.”
Please do not hesitate to consult us in the event you have any questions relating to the proper operation of your family limited partnership or other entity established to accomplish estate planning objectives, including asset protection and minimization of estate taxes. You can pay us now to protect you or you can pay us later to defend you against IRS action for failure to follow our structural and procedural advice.