The opinion issued on Sept. 29, 2016, in the case of Estate of Edward G. Beyer v. Commissioner of Internal Revenue was the culmination of an estate planning exercise that had an unfortunate ending for everyone involved (other than the IRS). The case involved a number of failed estate planning techniques.
The situation began when Edward Beyer, a Chicago resident and longtime executive at Abbott Laboratories, and Mr. Beyer’s nephew, Craig Plassmeyer, were introduced to attorneys at the firm of Madonia & Associates (Madonia) for the purpose of discussing and considering certain wealth transfer techniques. On the advice of Madonia, Mr. Beyer decided to form a limited partnership, the general partnership interest of which would be owned by revocable trust established by Mr. Beyer (GP revocable trust), with the limited partnership interest owned by a separate revocable trust also established by Mr. Beyer (LP revocable trust). The plan called for Mr. Beyer to form an irrevocable trust sometime after the formation of the limited partnership, which would purchase the limited partnership interest from the LP revocable trust.
Mr. Beyer named himself, Craig Plassmeyer and another of Beyer’s nephews, Bruce Plassmeyer, as the co-trustees of the LP revocable trust. The provisions of the LP revocable trust instrument obligated the LP revocable trust to pay any transfer taxes imposed by reason of Mr. Beyer’s death. Mr. Beyer also named his nephews Craig and Bruce Plassmeyer as the co-trustees of the GP revocable trust.
On Oct. 13, 2003, the trustees of the LP revocable trust and the GP revocable trust executed a limited partnership agreement in their respective capacities, thereby forming the Edward G. Beyer Limited Partnership under Illinois law. About six months after the formation of the limited partnership, a Madonia attorney advised Craig Plassmeyer that most of Mr. Beyer’s securities, including 800,000 shares of Abbott Laboratories stock, should be transferred from Mr. Beyer’s previously existing revocable trust (1999 revocable trust) to the limited partnership, while Mr. Beyer’s cash could remain in his personal account. The attorney indicated that “we need to establish to the IRS that [Mr. Beyer] has enough assets outside of [the limited partnership] to live on, and, given [Mr. Beyer’s] modest lifestyle, I think [$1.5 million] will do that.” The proposed transfer to the limited partnership was completed on April 20, 2004, and it left Mr. Beyer with about $4 million in assets owned either personally or through the LP revocable trust.
In April 2005, about a year after the limited partnership was funded, Mr. Beyer and his nephews began implementing the next phase of the estate plan proposed by Madonia. First, the trustees of the GP revocable trust entered into an investment account agreement with the Capital Trust Company of Delaware (Capital Trust), pursuant to which the limited partnership was required to deposit about 75 percent of its assets into a restricted management account (RMA). The investment agreement ran for four years unless extended by the parties, and it authorized Capital Trust to manage and invest the assets held in the RMA. The investment account agreement also required the limited partnership to obtain Capital Trust’s written consent prior to transferring any assets held in the RMA.
Next, Mr. Beyer formed an irrevocable trust (irrevocable trust) in April 2005, with Craig and Bruce Plassmeyer as co-trustees. On Dec. 30, 2005, the irrevocable trust purchased the LP revocable trust’s entire 99 percent limited partnership interest in exchange for a promissory note in the face amount of $20,866,725 (promissory note). The principal amount of the promissory note was payable to the LP revocable trust on Dec. 30, 2005, and the promissory note bore interest at a rate of 4.45 percent, compounded annually. The promissory note was secured by a security interest granted by the irrevocable trust in all of its accounts, accounts receivable, equipment and other tangible personal property. When the irrevocable trust issued the promissory note to the LP revocable trust, the irrevocable trust had only $10 of assets. Immediately following the transfer, the LP revocable trust’s assets consisted of the promissory note from the irrevocable trust and a bank account holding about $600,000.
On April 15, 2006, the trustees of the LP revocable trust drew a check in the amount of $659,660 payable to the IRS to cover the gift tax owed by Mr. Beyer for the 2005 taxable year. Then, on April 17, 2006, after the LP revocable trust had transferred its entire limited partnership interest to the irrevocable trust, $659,660 was transferred from the limited partnership’s bank account to the LP revocable trust’s bank account.
Mr. Beyer died on May 19, 2007, and several months later, during January and February 2008, the limited partnership sold a significant number of shares of stock. Then, on Feb. 12, 2008, the limited partnership transferred $250,000 to the LP revocable trust. On that same date, Craig Plassmeyer, as the Executor of Mr. Beyer’s estate, signed two checks drawn on the limited partnership’s checking account, each for $75,000. One check was payable to Craig Plassmeyer, the other to Bruce Plassmeyer, and the memorandum line of each check read “Administration Fee.”
The estate tax return for Mr. Beyer’s estate was filed by Craig Plassmeyer as Executor around Feb. 14, 2008, and the return showed net estate tax of $9,345,334. Four days later, on Feb. 18, Craig Plassmeyer signed a check drawn on the limited partnership’s checking account in the amount of $9,345,334 payable to the IRS. The following day, $9,945,000 was transferred from the limited partnership’s checking account to the LP revocable trust’s account.
The IRS issued a notice of deficiency to Mr. Beyer’s estate on Feb. 8, 2011. According to the IRS, the assets transferred by Mr. Beyer to the limited partnership were includable in Mr. Beyer’s gross estate under Section 2036(a).
Bona Fide Sale Exception to Section 2036(a)
Mr. Beyer’s estate argued that Section 2036(a) did not apply because the transfer to the limited partnership was a “bona fide sale for an adequate and full consideration….” The Tax Court disagreed, however, because the estate failed to establish that the transfer was “motivated by a legitimate and significant nontax purpose….”
According to the estate, the transfer was motivated by Mr. Beyer’s desire to (a) keep his Abbott stock in a single block, (b) transition Craig Plassmeyer into managing Mr. Beyer’s assets and (c) maintain continuity of management. The Tax Court rejected each purported motivation and noted that none of these objectives were identified in the limited partnership agreement’s boilerplate list of 28 purposes for the partnership. According to the Tax Court, Mr. Beyer could have achieved each of these objectives by amending his 1999 revocable trust instead of forming a limited partnership. The Tax Court also noted that the limited partnership agreement did not require the partnership to maintain the Abbott stock in a single block, and the general partner had the authority to sell the Abbott stock if necessary. Moreover, before the limited partnership was ever formed, Craig Plassmeyer already had the opportunity to manage Mr. Beyer’s assets as his attorney-in-fact.
According to the Tax Court, even if the estate did establish that the transfer to the limited partnership was motivated by a legitimate nontax purpose, the bona fide sale exception to 2036(a) still would not apply because Mr. Beyer did not receive adequate and full consideration in exchange for the assets transferred to the limited partnership. The estate claimed that adequate and full consideration was received because the capital accounts of both the LP revocable trust and the GP revocable trust were credited with the value of the assets transferred to the limited partnership, and, in the event of liquidation and dissolution, each revocable trust had the right to distributions in accordance with their respective capital accounts. The Tax Court rejected this claim and noted that the limited partnership never established separate capital accounts for its partners.
Possession or Enjoyment of the Transferred Property
Having concluded that the bona fide sale exception did not apply, the Tax Court next examined whether Mr. Beyer retained the possession or enjoyment of, or the right to the income from, the assets transferred to the limited partnership for purposes of Section 2036(a)(1). The Court found that there was an implied agreement or understanding that Mr. Beyer would retain the possession or enjoyment of the assets transferred to the limited partnership, and therefore the transferred assets were included in his gross estate.
According to the Tax Court, the April 17, 2006, transfer of $659,660 from the limited partnership to the LP revocable trust evidenced such an implied agreement or understanding. The transfer occurred after the LP revocable trust sold its limited partnership interest to the irrevocable trust, and the Tax Court observed that this payment was used by the LP revocable trust to pay Mr. Beyer’s 2005 gift tax liability.
The Tax Court also concluded that Mr. Beyer knew at the time of the initial funding of the limited partnership that the LP revocable trust lacked sufficient funds to pay the transfer taxes that would be owed upon Mr. Beyer’s death. The LP revocable trust was obligated to pay those transfer taxes under its governing instrument. Furthermore, the Court found that, when the LP revocable trust sold its limited partnership interest to the irrevocable trust, Mr. Beyer knew that the LP revocable trust would need to use a very substantial amount of the limited partnership’s assets to satisfy its obligation to pay the transfer taxes upon Mr. Beyer’s death.
The Tax Court also found the existence of an implied agreement or understanding supported by the fact that Mr. Beyer failed to retain sufficient assets outside of the limited partnership to pay his anticipated financial obligations. While Mr. Beyer retained about $4 million when the limited partnership was initially funded, those funds were significantly depleted by two gifts made by Mr. Beyer in 2005 to his nephews Craig and Bruce Plassmeyer, collectively totaling $2,500,000. Further, the Court noted that Mr. Beyer would not have used limited partnership assets to pay his 2005 gift tax liability of $659,660 if he had retained sufficient assets outside the limited partnership to satisfy his anticipated financial obligations.
Value of the Assets Included in Mr. Beyer’s Gross Estate
The assets transferred by Mr. Beyer to the limited partnership were included in Mr. Beyer’s gross estate. With that settled, the Tax Court set about determining whether the stipulated (and undisclosed) value of those assets could be discounted. The estate claimed that the value of the assets should be discounted based on the investment account agreement between Capital Trust and the limited partnership, pursuant to which Capital Trust held and managed 75 percent of the limited partnership’s assets. Under the terms of the agreement, distribution of principal from the restricted account was prohibited and the limited partnership could not transfer the assets in the account without Capital Trust’s written consent. Despite these restrictions, the Tax Court held that the estate could not discount the limited partnership assets held in the restricted account because the investment account agreement did not prohibit Capital Trust from selling the assets held in the account.
This case reminds us that the devil truly is in the details when it comes to family limited partnership planning. Establishing a legitimate nontax purpose, retaining sufficient personal assets, treating the partnership as a truly separate and distinct entity, establishing separate capital accounts – details such as these can and do mean the difference between a successful estate plan and an unexpected multimillion-dollar tax bill.