Chapter 16 - § 16.6 • DEVELOPMENTS SINCE STRANGI STRANGI

• Jurisdiction: Colorado

§ 16.6 • DEVELOPMENTS SINCE STRANGI

The IRS has prevailed in several cases since Strangi that involved unfavorable (to the taxpayer) facts.⁵⁸ However, cases since then were also decided in a manner that was very favorable to taxpayers. As seen in the following subsections of this § 16.6, where the cases were decided favorably to the taxpayer, two sets of facts predominate: first, the transaction was accomplished for business purposes in addition to the tax benefits received; and second, the entities followed appropriate formalities to maintain the operations of the FLP or FLLC separate from that of the patriarch or matriarch who established it.

§ 16.6.1—Kimbell v. United States

In Kimbell v. United States,⁵⁹ the Fifth Circuit Court of Appeals considered an LLC formed by Ruth Kimbell, her son, and her daughter-in-law. Ms. Kimbell owned a 50-percent interest in the LLC, and her son (who was the manager of the LLC) and daughter-in-law each owned 25-percent interests. Ms. Kimbell and the LLC formed a limited partnership. The LLC contributed one percent of the capital and took back a 1-percent general partnership interest. Ms. Kimbell contributed 99 percent of the capital and took back a 99-percent limited partnership interest. The assets Ms. Kimbell contributed to the limited partnership included cash, oil and gas working and royalty interests, securities, notes, and other assets. Two months after forming the limited partnership, Ms. Kimbell died at the age of 96.

Ms. Kimbell's estate valued the limited partnership interest at a discounted value of $1,257,000. The IRS valued the same interest at $2,463,000. The district court granted the IRS motion for summary judgment, holding that the property transferred to the limited partnership should be included in Ms. Kimbell's estate under I.R.C. § 2036. The Fifth Circuit reversed the district court, noting that there are two exceptions that will allow a transfer to avoid § 2036.

• The first is a transfer that is a bona fide sale for full and adequate consideration.
• The second exception is where the transferor does not retain either (1) the possession or enjoyment of the transferred property or (2) the right to designate who would possess or enjoy the property.

Analyzing the first exception — a bona fide sale for full and adequate consideration — the court of appeals held that an intra-family transfer does not have to meet any additional requirements if the objective facts indicate that a bona fide sale has taken place. Thus, for example, it did not matter that there had been no negotiations in this case. The appellate court stated that for the consideration to be full and adequate, the exchange of assets between the transferor and the partnership must be roughly equivalent so that the transfer does not deplete the transferor's estate. For a transfer to qualify as a bona fide sale, there must be a transfer in which the transferor actually parts with his or her interests in the assets, and the partnership actually parts with interests issued in exchange.

The appellate court also stated that when a transaction is between family members, heightened scrutiny is appropriate to make sure that the transfer is not a sham transaction or a disguised gift, but the scrutiny is limited to an examination of objective facts. The court stated that it was not relevant that the value of the partnership interest received by the decedent might be less than the value of the assets contributed because of lack of marketability or other discounts. Instead, the proper focus is a three-part test:

1) Were the partnership interests credited to each partner proportionate to the fair market value of the assets contributed by that partner?
2) Were the assets so contributed credited properly to the partners' respective capital accounts?
3) Upon dissolution of the partnership, were all partners entitled to distributions equal to their respective capital accounts?

The court also stated that in this case even if there had not been a bona fide sale for adequate and full consideration, Ms. Kimbell did not retain enough control over the assets transferred to trigger I.R.C. § 2036 because she owned only 50 percent of the LLC general partner and her son was the manager of the LLC.

§ 16.6.2—Estate of Mirowski v. Commissioner

In Estate of Mirowski v. Commissioner,⁶⁰ the court rejected IRS arguments under I.R.C. §§ 2036(a)(1) and (a)(2), 2035, and 2038(a)(1). The decedent had transferred valuable medical device patents and securities with an aggregate value of $62,103,306 to a family limited liability company (FLLC). On the same day, she gifted a 16 percent membership interest to each of her three daughters, retaining a 52 percent membership interest. She retained substantial assets outside the FLLC, but not enough to pay the gift tax on the gifts of the FLLC membership interests. Mrs. Mirowski unexpectedly died four days after making the gifts to her daughters. The Tax Court determined that there were three legitimate and significant non-tax reasons for the FLLC contributions:

1) Joint management of the family's assets by Mrs. Mirowski and her daughters, and eventually her grandchildren, with the objective of fostering family cohesiveness;
2) Maintenance of the bulk of the family's assets in a single pool to take advantage of lower investment management fees and to allow for investment opportunities that would otherwise not be available; and
3) Providing for each of her daughters and eventually each of her grandchildren on an equal basis.

Mrs. Mirowski's counsel also argued for a fourth non-tax purpose — additional protection for Mrs. Mirowski's descendants from claims of potential creditors (such as in a divorce setting). The court held this fourth purpose to be legitimate but not significant because the trusts that were to receive the gifts already included spendthrift provisions providing substantial...