Stone v. Comm’r, TC Memo 2012-48 is yet another confirmation that when structured correctly, the taxpayer typically defeats the IRS in a Section 2036 case.
Background
Joanne Stone (“Decedent”) and her husband owned either wholly or in part approximately 30 parcels of real property in Tennessee, of which nine parcels were mostly undeveloped woodlands. To advance their family planning regarding the woodland parcels, Mrs. Stone and her husband formed the Stone Family Limited Partnership (“SFLP”) on December 29, 1997. At the time of formation, Mrs. Stone and her husband were in their 70s and 80s, respectively, and in good health. SFLP was created for the purpose of holding and managing certain woodland property. Originally, Mrs. Stone and her husband both owned all of the general and limited partnership interests in SFLP. The partnership agreement was revised two days after formation on December 31, 1997, with the only change being that 21 of Mrs. Stone’s children, children’s spouses, and grandchildren each received gifts of 0.634 percent limited partnership interests. Similar gifts were made again in 1998 and 1999. In 2000, 0.477 percent limited partnership interests were gifted to each of the 19 remaining family members1. By the end of 2000, Mrs. Stone and her husband each owned 1.0 percent general partnership interests in SFLP, while their children, children’s spouses, and grandchildren owned the remaining 98 percent limited partnership interests.
We note that all of the aforementioned gifts of limited partnership interests were on a pro-rata basis of the appraised value of the underlying real estate held by SFLP. In other words, no discounts for lack of control and lack of marketability were taken. In addition, SFLP earned no income and its only expenses were property taxes of approximately $700 per year, which were paid from the personal funds of Mrs. Stone and her husband. As previously noted, two of Mrs. Stone’s children’s spouses did not receive interests as a result of divorce proceedings in 1999 and 2000. Separate divorce settlements with their respective spouses involved the transfer of property interests in the woodland parcels held by SFLP, but not a transfer of actual SFLP interests. Finally, Mrs. Stone and her husband made no particular use of the real estate held by SFLP and all of the limited partners in SFLP had the same access to the land.
At issue was whether the value of the assets transferred by Mrs. Stone and her husband to SFLP should be included in the value of her gross estate under Section 2036 (a).
Court Discussion
As further explained below, under the bona-fide sale test of Section 2036, the IRS’ two primary arguments that SFLP did not have a nontax purpose, were all rejected by the Court.
- Did the transfer of the real estate to SFLP qualify as a bona fide sale? The estate argued that Mrs. Stone and her husband had two nontax motives for transferring the woodland parcels to SFLP: (i) to create a family asset which later may be developed and sold by the family; and (ii) to protect the woodland parcels from division as a result of partition actions. The IRS argued that Mrs. Stone and her husband were motivated only by a desire to simplify the gift-giving process. While the Court agreed with the IRS that gift giving alone is not an acceptable nontax motive, it did not agree that gift giving was the Decedent’s only motive in transferring the woodland parcels to SFLP.
The IRS also contended that since Mrs. Stone and her husband were on “both sides of the transaction,” the bona fide transfer exception would not apply (Liljestrand v. Comm’r2). However, the Court noted that this situation is allowed if there is a legitimate nontax purpose for the transaction (Bongard v. Comm’r3).
Lastly, the IRS argued that the partners of SFLP failed to respect partnership formalities4. However, other factors support the estate’s argument that a bona fide sale occurred. First, Mrs. Stone and her husband did not depend on distributions from SFLP as no distributions were ever made. Second, Mrs. Stone and her husband did transfer the woodland parcels to SFLP. Third, there was no commingling of partners’ personal and partnership funds, as SFLP had no partnership funds. Fourth, no discounting of the limited partnership interests in SFLP for gift tax purposes occurred. Finally, the evidence presented tended to show that Mrs. Stone and her husband were in good health at the time the transfer of the woodland parcels was made to SFLP.
After considering all of the facts presented, the Court found that Mrs. Stone and her husband had a legitimate and actual nontax motive in transferring the woodland parcels to SFLP. - Did Mrs. Stone and her husband receive full and adequate consideration for the transfer of the real estate to SFLP? As the Court had already found that decedent had a legitimate and actual nontax purpose in transferring the woodland parcels to SFLP, the Court therefore found that the transaction was not merely an attempt to change the form in which Mrs. Stone and her husband held the woodland parcels and that the full and adequate consideration criteria was satisfied since they each received interests in SFLP proportional to the property they contributed to SFLP.
FINAL COMMENTARY
Has the IRS become a victim of its own prior success on Section 2036? Have the Service’s professionals seen so many victories in “bad facts cases” that they think the same analysis will save the day even when the facts are less bad? In Stone, certainly, there were bad facts. There were minor lapses in adhering to partnership formalities. But the business purpose for the partnership was clearly documented and logical given the Stone family’s situation. The case is a validation of the FLP as an estate planning technique and yet another confirmation that, unless large errors are committed, the Tax Court will not pull assets back in the estate once gifted. It seems the IRS may need to develop another trick.
1 Two of Mrs. Stone’s children’s spouses did not receive interests as a result of divorce proceedings in 1999 and 2000.
2 Estate of Liljestrand v. Commissioner, T.C. Memo 2011-259.
3 Estate of Bongard v. Commissioner, 124 T.C. at 121.
4 Because: (i) in divorce proceedings, the family members renounced all claim to their interests in the woodland parcels to their former spouses but did not transfer actual SFLP interests; (ii) some inadequate documentation was kept for the partnership, such as using bills of sale to make gifts of SFLP interests; and (iii) Mrs. Stone and her husband paid SFLP property taxes out of their personal funds.