On August 7, 2008, a taxpayer’s son and heir formed a family limited partnership. Then, using the power of attorney for his mother, he transferred $10 million of his Mother’s cash and securities that were in a revocable trust to the partnership in exchange for a 99% interest. That son and his brother contributed unsecured notes in return for a 1% interest in the partnership. On that same day, the son transferred his Mother’s partnership interest to a charitable lead annuity trust.
The Mother died on August 15, 2008, just seven days later. What was the son trying to do? In what the U.S. Tax Court called “aggressive deathbed tax planning”, the son was trying to keep the assets out of the Mother’s taxable estate and to get a discounted value for the remainder interest the sons had in the charitable trust. Siding with the IRS in Estate of Nancy H. Powell v. Commissioner, the Court didn’t buy it. Instead, the Tax Court held that the value of the assets transferred to the partnership had to be brought back into the estate, which resulted in a tax deficiency of over $5 million for Nancy Powell’s estate.
The Court’s holding is far-reaching because it relied upon a little-used provision in the estate tax law and it extended that rule to decedents owning only a limited partnership interest. That provision, Code Sec. 2036(a)(2), requires inclusion in an estate of property if the decedent had “a right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.” The Court reasoned that (1) the decedent, in conjunction with all the other partners, could dissolve the partnership; and (2) the decedent, through her son as the general partner and as her agent, could control the amount and timing of distributions. The fact that her interest was only a limited partnership interest did not deter the Court.
The judges also determined that the property should come into the taxable estate under another rule–that her assets were transferred less than three years before her death. Finally, the Court said the transfer of the Mother’s interest to the charity was either void or revocable under California law because the son’s power of attorney did not authorize the son to make gifts in excess of the annual gift tax exclusion.
Sound complicated? It is. Estate and gift tax professionals will be talking about the implications of the Estate of Powell case for a long time. For taxpayers the lesson is this: estate tax planning is a very complex undertaking. As one can see from this case, last minute efforts are fraught with problems. The best practice is to consult your Frazier & Deeter advisors to help with your family’s wealth planning well in advance of the type of exigencies faced by the Powell family.