Bongard: tax court incorrectly expands Sec. 2036(a)'s application.

• Author: Satchit, Vinu

Sec. 2036(a) includes in a transferors gross estate the entire value of a lifetime transfer of property if he or she has retained, through explicit or implied agreements, one or more of the valuable economic benefits associated with property ownership (i.e. , the right to possess or enjoy the property, the right to income therefrom or the right to designate the person(s) who would enjoy such rights (collectively, "prohibited rights")). The statute does not apply to transfers that are bona fide sales for full and adequate consideration (bona fide sale exception).

Avoiding Estate Tax

Although enacted in 1931, Sec. 2036(a)'s underlying premise--that title, possession and enjoyment of property need to be transferred to avoid inclusion in the transferor's estate tax base--had been present in the tax law since the early 1800s. In those days, taxpayers attempted to avoid the imposition of state inheritance taxes by transferring title to property while retaining the right to income from it. State inheritance tax provisions, enacted as early as 1826, frustrated such attempts by including lifetime transfers in the inheritance tax base if the "possession or enjoyment of the property was intended to take effect only at death."

The 1916 Federal estate tax code also required the inclusion in the decedent's gross estate of lifetime transfers intended to take effect, in possession or enjoyment, at death. From 1916-1930, Treasury treated transfers to trusts designed to distribute the corpus at the grantor's death and which reserved a life income to the grantor as transfers "intended to take effect at death." (1)

The Supreme Court, however, took issue with such treatment in 1930. In May v. Heiner, (2) the taxpayer transferred assets to a trust that provided benefits to her husband for life, then to her for life, and then to her children. The Supreme Court, reversing the Third Circuit, concluded that the critical moment for determining whether property was includible in the gross estate was the point of passage of fee simple title. Because title had passed to the trust, the transfer was not includible in the gross estate. In response to the Supreme Court's holding in Heiner and other cases, Sec. 2036(a)(1)'s predecessor was enacted in 1931. (3)

Sec. 2036(a) and FLPs

In recent years, the Tax Court has agreed in many cases with the Service's argument that assets transferred to family limited partnerships (FLPs) were includible in the transferor's estate under Sec. 2036(a). In determining whether a transferor has implicitly retained an economic benefit under Sec. 2036(a)(1), the courts typically look at all of the facts and circumstances surrounding the transfer and the subsequent use of the property In all of the earlier cases involving Sec. 2036(a), (4) analyses of the property's subsequent use provided objective evidence that the taxpayer continued to possess and enjoy the property (or the income therefrom), as exhibited by one or more of the following facts:

* The income continued to be deposited in the transferor's accounts;

* The FLPs made disproportionate distributions and interest-free loans to meet the transferor's living expenses;

* The FLPs paid the taxpayer's personal expenses directly;

* The transfers were not properly recorded under state law; and

* The taxpayer continued to use the transferred property without paying rent.

Clearly, these facts evidence that while the decedents may have technically transferred title to the property to the FLP during life, they never actually parted with some or all of the valuable economic attributes associated with ownership (like the right to income or use). Thus, although the application might be clumsy, and the process fraught with technical hurdles (5) (especially when applying the bona fide sale exception), the results are justified in these cases, because retention of possession or enjoyment of the transferred property is exactly the problem Sec. 2036(a) was enacted to address. In these cases, the taxpayers literally retained possession or enjoyment.

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