In Estate of Nancy H. Powell (148 TC 18, 5/18/17), another taxpayer at death’s door failed to achieve any estate savings through the creation and funding of a limited partnership called NHP Enterprises, LP (“NHP”). Nancy Powell’s son Jeffrey, acting under a power of attorney for his mother, formed NHP on August 6, 2008, and on August 8, he transferred cash and securities to it in the amount of $10 million. Jeffrey was the general partner, holding a 1% interest, and Mrs. Powell’s revocable trust held a 99% interest as a limited partner. The partnership agreement allowed the general partner to determine the amount and timing of distributions. NHP could be dissolved with the consent of all partners.
On August 8, Jeffrey, purporting to act under his power of attorney, transferred the 99% interest held by Mrs. Powell’s trust to a charitable lead annuity trust (“CLAT”) that would pay an annuity to the Nancy N. Powell Foundation each year, for the remainder of Mrs. Powell’s life. Upon Mrs. Powell’s death, any assets remaining in the CLAT were to be divided equally between Jeffrey and his brother. Mrs. Powell died a week later on August 15. A small gift was reported on a gift tax return filed after Mrs. Powell’s death for the claimed value of the remainder interest in the trust going to Mrs. Powell’s sons at her death.
The IRS proposed both a gift tax deficiency and an estate tax deficiency as a result of the above events. Before the Tax Court, the IRS took the position that the assets transferred to NHP were includible in Mrs. Powell’s estate under IRC Sections 2036(a)(1), 2036(a)(2), or 2038. Section 2036(a)(1) includes property transferred by a decedent during their lifetime if the decedent retained the possession, enjoyment or right to income from the property. Section 2036(a)(2) includes property transferred where the decedent retained the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.
According to the IRS, Section 2036(a)(1) applied because there was an implied agreement under which Mrs. Powell retained the possession, enjoyment or income from the property that was transferred to NHP. The court did not address this argument or the possibility of inclusion under Section 2038, because it found that Section 2036(a)(2) applied. This alone is significant because it is the first time the court has applied the (a)(2) provision to include assets transferred to a family partnership without concluding they could also be included under Section 2036(a)(1). Here, the court never took up the 2036(a)(1) arguments and instead based inclusion directly on Section 2036(a)(2). Adding to the significance of the court’s finding, the inclusion under 2036(a)(2) was determined even though the decedent never had anything other than a limited partnership interest, because she could vote with the general partner to dissolve the partnership and thereby control the disposition of the assets.
In the Tax Court, the estate conceded that Section 2036(a)(2) would have applied if the decedent had retained any interest in NHP at her death because she, in conjunction with Jeffrey, could dissolve the partnership and thereby control the disposition of the assets transferred to it. The estate’s argument was that this provision could not apply because prior to her death she was divested of her entire interest through the gift of her interest to the CLAT.
The Tax Court determined that the divestiture argument failed for two reasons. First, the power of attorney did not authorize Jeffrey to make a gift in excess of the annual exclusion amount provided in Section 2503(b). Even if the gift had been valid, Section 2036(a)(2) would still be applicable through the operation of Section 2035(a). This section provides that if a decedent makes a transfer, retains a power that would result in inclusion under any of Sections 2036, 2037, 2038 or 2042, and within three years of his or her death relinquishes the proscribed power, the value of the transferred property is included in the decedent’s gross estate.
The court determined that the gift of the interest in NHP to the CLAT amounted to the relinquishment of the decedent’s retained power to dissolve NHP and control the disposition of its assets. Since the gift occurred within three years of the death of Mrs. Powell, Section 2035(a) pulled the value of the transferred assets back into her estate.
The court’s willingness to apply Section 2036(a)(2) where the decedent held only an interest as a limited partner makes the retention of any interest in a family partnership, whether general or limited, by a family member who transfers assets to it a high risk proposition, since most partnerships can be dissolved if the partners act together to do so. Furthermore, any transfer of the interests in such a partnership to other family members should occur more than three years before the likely death of the family member making the transfer in order to protect against inclusion under Section 2035. That said, this case is a classic example of the old maxim that “bad facts make bad law.” The case may be appealed. In many family partnership situations the bona fide sale exception will prevent IRC Sections 2036 or 2038 from being applicable.