Many of the cases involving family limited partnerships on which we report have been cases where the taxpayer lost because it did not build a good factual foundation for the partnership. Estate of Lockett, T.C. Memo 2012-123 (April 25, 2012) is yet another example of such a taxpayer failure. The taxpayer, Mrs. Lockett, created a family partnership in which she, and a trust created for her at her husband’s death, were the limited partners, and in which her two sons were the general partners. She and the trust contributed property to the partnership but the sons did not make any contribution. The trust was subsequently dissolved and Mrs. Lockett became the owner of the limited partnership interest previously held by the trust. Schedule A attached to the partnership agreement showed that the taxpayer had a 100 percent interest in the partnership and her two sons, although general partners, had a 0 percent interest, and partnership income tax returns allocated all items of income and deduction to Mrs. Lockett.
Following Mrs. Lockett’s death, the estate tax return filed for her estate showed the taxpayer as the owner of 100 percent of the partnership, but claimed an approximate 40 percent valuation discount based on lack of control and marketability with respect to her partnership interest. The IRS took the position that no partnership existed and the taxpayer’s estate should be treated as owning the partnership assets directly, in which case no discount would be applicable.
The court agreed with the IRS. While the sons were listed as general partners, the court found that they neither contributed capital nor rendered significant services to the partnership in order to obtain any interest. There was no evidence that Mrs. Lockett made any gifts of partnership interest to them, and both the partnership income tax returns and her estate tax return showed her as the 100 percent owner. The court said that while a partnership existed when Mrs. Lockett and the trust were partners, upon the dissolution of the trust, she became the sole owner and an entity seeking to be treated as a partnership under the tax law cannot have only one partner.
The case suggests poor planning on the part of the taxpayer and her family – although in her defense, Mrs. Lockett did die unexpectedly. She and her children may have had a plan for her to make gifts of partnership interest and that plan was interrupted by her unexpected death. While it is generally good planning to allow some time to elapse between the transfer of assets to a family partnership and subsequent gifts of partnership interests, this case certainly points out a risk that is inherent in waiting to make gifts.