In “How soon is it now: Estate of Moore & the Unraveling of Deathbed Estate Planning “, Professor Beckett G. Cantley and Geoffrey C. Dietrich discuss in detail the interpretation and application of the Internal Revenue Code Section 2036 by the tax court to so-called deathbed transfers, including relevant cases Moors, and the policy behind the tax court’s interpretation of the rules.
Cantley and Dietrich begin with a brief summary of state gift and inheritance tax laws as they apply today to individuals who give gifts or have a taxable estate greater than $ 11.7 million. They then explain common end-of-life transactions that can attract the attention of the Internal Revenue Service and warn against such last-minute planning due to uncertainty as to whether such deathbed planning will actually achieve the testator’s tax goals.
Two transactions that are frequently reviewed by the IRS include: (i) Family Limited Partnerships (FLP) and (ii) the use of haircuts to take advantage of the lifetime gift tax exemption. In the context of an FLP, family members act as general partners or limited partners in a family business or another asset pool. Instead of a capital contribution to the FLP, limited partners are given their participation as a gift from a senior family member and have little control over the management of the FLP. These limited partners’ interests generally have a lower value than the underlying assets of the FLP because the interest is non-marketable and the limited partner does not control the FLP, both of which result in a lower valuation of the company’s shares for real estate or gift tax purposes.
The article states that the opportunity to transfer FLP shares at a discount does not end with the initial transfer of ownership shares to a limited partner, but can also be continued in other estate and tax planning transactions. The transfer of an FLP participation to a Grantor Retained Annuity Trust (GRAT) or Charitable Lead Annuity Trust (CLAT) enables the Grantor to take an additional valuation discount for the retained right to the FLP’s income stream for a period of years, which a lower than the transfer of FLP shares as a direct gift. Sales to children, other family members, or trusts also provide an opportunity to transfer FLP shares believed to be less than the direct sale of the underlying assets. While the sale will result in the frozen value of the FLP stake remaining in the transferor’s estate, all of the increase in value from the estate will be transferred to the buyer with little or no gift tax exemption.
While the article provides a simplified explanation of the mechanisms of GRATs and CLATs, Cantley and Dietrich could clarify how these specific trust structures differ from other types of trusts to allow for further discounting, particularly through a brief discussion of the IRC sections 2702 and 7520.
IRC section 2036 (a)
IRC Section 2036 (a) includes in the value of the gross assets of a testator any property in which the testator retained possession or enjoyment, had the right to own or enjoy that property, or to determine who owns or enjoys that property target. The article provides an insight into the intentions of Congress behind the purpose of this section, and then goes into the IRS and Tax Court’s interpretation and application of IRC Section 2036 in the basic cases. Bongard estate, Strangi’s estate, Powell estate and Moore estate.
In each of these cases, the tax court used the following test to determine whether IRC Section 2036 applies to the transfer of property, namely FLP interests: (1) the testator has transferred property for life; (2) the transfer was not a bona fide Sale for fair and full consideration which requires a legitimate non-tax reason for the FLP; and (3) the testator retained any right listed in section 2036 (a) (1) or (2) or (b) to the transferred property that the testator did not give up prior to death.
Cantley and Dietrich then discuss their take on the policy behind the application of Section 2036, focusing primarily on its implications for deathbed transfers. Although the relevant case law reflects a pattern of remittances for tax planning purposes very shortly before the transferor’s death, the article’s focus on the relationship between the application of Section 2036 and deathbed planning may be too strong. While it is correct to use these cases and Section 2036 in conjunction with IRC Section 2035 to warn of end-of-life tax planning, it is important to note that timing of a transfer is not part of the multi-parted Section 2036 review by the tax court . Deathbed transfers clearly support the argument that there was no legitimate non-tax reason for the establishment of the FLP, but that argument could be used in any situation where an FLP was established as part of a comprehensive estate and tax planning structure. Cantley and Dietrich point out this risk in their discussion of the steps to avoid the application of Section 2036 that Section 2036 should be considered for all FLP transfers (not just deathbed transfers), but could be clearer in their explanation.