Recently, the U.S. Tax Court found the estate of Edward Beyer liable for an additional $24 million in taxes and penalties, concluding that the assets Mr. Beyer transferred to a limited partnership did not fall within the bona fide sale exception to 2036(a) and were includible in his estate at full fair market value. Estate of Edward G. Beyer v, Commissioner, T.C. Memo. 2016-183; No. 10231-11 (Sept. 29, 2016).
Mr. Beyer acquired 800,000 shares of Abbott Laboratories stock throughout his tenure working at Abbott. In 2003, at the advanced age of 93, and upon advice of newly obtained counsel, he transferred the stock into a limited partnership, with two revocable grantor trusts as the "partners," a "Living Trust" to serve as the limited partner and a "Management Trust" to serve as the general partner. In 2005 the "Living Trust" sold its entire limited partnership interest to a new irrevocable trust in exchange for a promissory note. While Beyer never married and had no children, he had identified his nephew as his successor in managing his assets, granting the nephew a broad power of attorney over his affairs and naming him as successor trustee of each of Beyer’s trusts.
Evidence Lacking of Valid Nontax Business Purpose
The court focused on the legitimacy of the transfer of property to the limited partnership under the bona fide sale exception to 2036(a), holding that the transfer was not a bona fide sale because the estate failed to demonstrate the transfer was motivated by a significant and legitimate nontax business purpose. The estate argued in the Tax Court that Beyer had three valid nontax business purposes in forming and transferring assets to the partnership: (1) keeping the Abbott stock in a block and maintaining the investment portfolio intact; (2) transitioning management of the assets to Beyer’s nephew; and (3) ensuring continuity of management (notwithstanding that none of these purposes were contained in the partnership agreement). The court accepted that such motivations could be valid nontax business purposes but did not accept the validity of these purposes given the facts of this particular case.
While the partnership agreement contained 28 boilerplate purposes, the three nontax business purposes alleged by the estate were not among the listed purposes. In addition, the court found that Beyer did not need a limited partnership structure to achieve these purposes but could have achieved the same results by amending his existing trust agreement to ensure the Abbott stock block remained intact and to give his nephew additional management power during Beyer’s lifetime. Finally, the partnership agreement contained no provisions that would require the Abbott stock to be held in a block, suggesting to the court that this could not have been a significant motivation in creating the partnership.
The court's analysis appears to have placed a heightened evidentiary burden for estates attempting to demonstrate a valid nontax business purpose, suggesting the following:
- The alleged nontax business purpose should be explicitly listed in the section of the partnership agreement outlining the partnership’s purposes and scope
- The partnership should be a necessary structure to effectuate the nontax business purpose. That is, if the nontax business purpose could be achieved under the transferor's existing trusts or other entities, without transferring assets into a limited partnership, this might suggest the partnership was in fact motivated primarily by tax savings
- The limited partnership agreement should include operative provisions that clearly effectuate the nontax business purpose
The implications of this heightened evidentiary burden to demonstrate valid business purpose are particularly salient in light of the recently proposed 2704 regulations, which would deny valuation discounts to family limited partnership interests. Given that the days of the partnership valuation discount may be numbered for family partnerships, the IRS and courts may easily presume that partnerships created and used to transfer assets as a result of the announcement of the proposed regulations are motivated primarily to take advantage of the transfer tax savings before this planning device potentially disappears. While Estate of Beyer does not suggest that tax motivations entirely preclude a finding of a valid nontax business purpose, it does raise the bar in terms of the amount and type of evidence the estate might need to put forth to prove a nontax business purpose. Individuals rushing to take advantage of partnership discounting during this period should therefore take even greater care to solidify and properly evidence nontax business purposes in accordance with the court’s conclusions in Estate of Beyer.
Bad Facts and Avoidable Mistakes
Estate of Beyer also highlights a number of bad facts and risk factors estate planners should take note of and which could have been avoided with proper guidance:
- Failure to simply file a Form 709 and make proper elections regarding 529 accounts led to an additional $5 million liability (including penalties)
- Beyer was 93 when he engaged in comprehensive estate planning structures. While the court does not mention concerns regarding deathbed planning, Mr. Beyer’s advanced age may suggest pure tax motivations in his planning.
- The court was particularly bothered in its 2036 analysis by the lack of regard for partnership formalities and facts suggesting an implied agreement that Beyer would continue to enjoy assets transferred to the partnership, such as:
- Failure to maintain proper capital accounts
- Partnership returns filed in all relevant years that were entirely inconsistent as to ownership percentages and capital accounts
- Direct payments from the partnership to the Living Trust to correspond to Beyer’s gift tax liability, notwithstanding that the Living Trust was no longer a partner entitled to distributions
- Beyer’s failure to retain sufficient assets outside the partnership