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 2004
Index (back)
Report 6
Wednesday, January 7
10:45 a.m. - 12:15 p.m.
Question & Answer Session
Dennis I. Belcher
Carol A. Harrington
Prof. Jeffrey N. Pennell
Reporter: Gene Zuspann Esq.
They received 100+ questions
Impact of HIPPA
Sets privacy standards for medical information _ certain entities
(health plans, providers and clearinghouses) may not disclose
info to anyone other than patient or POA agent
How does this affect an EP practice
Removal of trustee for incapacity _ medical provider may not
longer provide this without a separate authorization signed
by that patient
HCPOA still allows agent to make decisions _ should specifically
provide that agent should be personal representative under
HIPPA (designating specific section of Act which I did not
get)
Should execute a separate authorization to holder to get info
from doctor and check with Dr and hospitals to see what they
require
Strangi was appealed and will go to Fifth Circuit; ACTEC
will file an amicus brief
Tax apportionment _ can you apportion tax to an inter vivos
donee by a Will?
The issue could apply to the 3 year rule bringing back gift
tax into an estate
Jeff only knows of 3 cases dealing with the issue _ 2 allocate
the liability to the donees and one does not do so
What is the result under the Uniform Estate Tax Apportionment
Act? They did not allocate this in the Act assuming that the
gift tax liability was the donor's. Jeff is not sure this
is correct. This should be addressed in your tax clause and
in the deed of gift.
Jeff also addressed a difference in estate tax rates due to
lifetime gifts causing additional tax in the estate but he
would not try and draft for this issue
Dennis directed the audience to the Stone decision where the
taxpayers tried to address the gift tax.
Question of basis and FLP's
Dennis discussed the difference in inside and outside basis
due to a valuation discount and the §754 election.
§643 regulation issues (Carol)
§643 regs address §1001 issue. Although this is
not 'clean' it was the best the Service could do given that
the §643 project was already open.
The trustee must be consistent on allocation of capital gains
to income and observe a duty of impartiality
Sometimes you can use Strangi to your advantage, for instance,
if values went down. If you allow 2036 to apply, then all
of the tax effects of including the asset in the estate. However,
there are a number of issues involved with this.
Defined value clauses. You are looking at a method of limiting
the estate tax payment. Consider the possibility of a disclaimer.
The trust would provide that the interest would go to the
child, but if he/she disclaimed, then it would go to the family
foundation. The question submitted asked whether this is good
- Dennis said that it depends on the family. Caveat: The person
disclaiming must be careful of any problems that the disclaimer
could cause for the FF and its operation and the potential
excise tax issues.
Can a 5 year old trust with a 25% inclusion ratio be split
into a trust with a zero inclusion ratio and a trust with
an inclusion ratio of 1? Carol answered in the affirmative.
This authority was granted in a 2001 change in the law. See
the statute and regs for authority and requirements of the
split. You can do this without court approval if your state
law allows it. You need to notify the Cincinnati Service Center
of the change. If the donor is alive do a gift tax return
explaining the change in allocation. If not, mail a document
to the IRS showing the change.
Jeff discussed a question on FLP's. He addressed judicial
activism (a conclusion of the person submitting the question
and adopted by the panel) as the courts have realized that
the Service has lost all of its arguments but that the courts
feel that the discounts are unsustainable. Jeff feels that
the judges are saying that in the bad fact situations, the
taxpayer should not succeed. He feels the Fifth Circuit in
Strangi may do what they did in Church - exercise the smell
test and leave the result alone, regardless of the problems
with the lower court decision.
§2036 and the marital deduction (Dennis)
a problem exists if the decedent has used the applicable exclusion
amount and a gift comes back under 2036. If there is no ability
to get the money from the donees, the gift tax will affect
the marital deduction and cause significant additional tax
(a circular calculation)
It is wise not to fund your marital share until after you
complete your audit
Defenses to Strangi (partially suggested by Stacy Eastland)
Make distributions from entity mandatory
Make power to liquidate in an entity not owned by the transferor
No investment authority in transferor
Reasonably definite external authority
Jeff suggests that you follow the same approach you would
take to drafting a trust; Dennis also suggests following the
business model (Stone). Jeff does not feel that you should
rely on the Byrum defense. He feels this a litigation defense.
2:00 - 3:30 p.m. Special Sessions 1
Session 1-B - Bulletproofing the FLP - Current Issues
John W. Porter
T. Randall Grove
Reporter: Carol Warnick Esq.
John Porter and T. Randall Grove did most of the talking,
although they noted that their Special Session Materials contained
two relevant articles, which are listed below. They announced
that they were providing microphones for the authors of those
articles to make comments at any time during the presentation.
They asked that all other comments or questions be put in
writing and submitted to them in that fashion.
The articles were:
Strangi; A Critical Analysis and Planning Suggestions, BY
Mitchell M. Gans and Jonathan G. Blattmachr, 2003 Mitchell
M. Gans and Jonathan G. Blattmachr, Published in Tax Notes,
September 1, 2003, pg 1153.
New Tax Court Cases: Developments in Planning with Family
Limited Partnerships, by S. Stacy Eastland, 2003, Stacy Eastland,
Published in ACTEC Journal, Fall 2003 Vol 29. No. 2, p. 69.
John Porter started out going over what he talked about yesterday.
He again emphasized that we should work to make these entities
commercially reasonable. Many things we like to include in
partnerships, such a prohibiting withdrawal, only allowing
withdrawal with a penalty, requiring a high number of affirmative
votes before liquidation, etc. are also common in commercial
deals.
He feels that 2703 was specifically set up to deal with abusive
buy-sell arrangements. The Service has lost many of the other
arguments against FLPs.
As he discussed yesterday, the gift on formation argument
is really dropping out. In Strangi, they based the argument
on the partnership's own appraisal. The Service felt that
something had happened to the values, they disappeared somehow
in the process therefore there must have been a gift on formation.
The Tax Court threw that argument out and said that what Mr.
Strangi received was worth about the same as what he put in,
in spite of the valuation appraisal showing discounts.
The Jones case put the gift on formation argument to bed
with the same analysis. If the capital accounts are properly
credited and this is a pro rata partnership, there is no gift
on formation. Contrast this with the Shepherd case, where
50% of what he contributed was credited to his two sons' capital
accounts (25% to each son). Make sure that when the partnership
is created and when a partner contributes property to the
partnership, that the value of the property is appropriately
credited to his or her capital account.
Strangi II T. Randall Grove says it is a testamentary devise
case. He thinks that comment right out of the box in the opinion
had a very significant impact on the rest of the opinion.
Mr. Strangi retained the right to enjoyment of the assets
in Strings. How did they get there? Mr. Gulig had power of
attorney. This looks more like one man's estate plan than
a joint enterprise. The fiduciary duty Mr. Gulig owed to Mr.
Strangi allowed to court to come up with the retained right
issue.
He discussed how Mr. Strangi continued to use his personal
residence, how he did not have sufficient assets in his own
name to continue to live the way he had been accustomed, and
the most critical factor, which was that nothing really changed
in the management, etc. of the assets. Mr. Gulig continued
to manage afterwards, just as he did before. Grove thinks
the court was greatly influenced by the fact that the whole
arrangement looked like one man's testamentary devise.
2036(a)(2) issue Court said it distinguished Strangi from
Byrum because Byrum had an independent trustee. Court also
said they were ignoring the identity of the other shareholders.
(Family members, with only a sliver of interest going to charity.)
There was a high unlikelihood of the shareholders bringing
any accountability into the mix, both terms of who they are
but also in how small their interest was.
Porter This upsets him because the courts seem to think that
family members will not enforce fiduciary obligations. We
as practitioners know that family members do sue other family
members. We see it all the time. Will this be a battleground
in the appeal of Strangi II? Also make sure that the partnership
agreement does not negate fiduciary duties as in Kimbell.
Question: What impact did Mr. Gulig's role as attorney in
fact have on the court, given the other issues as well?
Answer: The Court never got beyond the fact that Mr. Gulig
was the attorney in fact for Mr. Strangi, even though he had
fiduciary duties to others under the FLP agreement.
Very broad discretionary powers to Gulig in partnership agreement.
Maybe better off with ascertainable standards regarding distributions,
which should avoid the 2036(a)(2) problem. We won't see that
in Strangi because there are no ascertainable standards in
the agreement.
Mitchell Gans asked whether or not ascertainable standards
are really necessary? It was not in Byrum. It was a corporate
fiduciary standard. Does Byrum stand for the proposition that
corporate fiduciary duties are the same as what we term ascertainable
standards?
Porter: He thinks you need both the fiduciary duties and
ascertainable standards to avoid the (a)(2) problem.
Mitchell: Thinks that corporate fiduciary duty is analogous
to the ascertainable standards in trust law.
Porter: In a partnership, if income is not distributed, it
must be credited to the partner's capital accounts. The general
partner may control when they get it, but can not decide to
give it to some other partner's capital account.
Mitchell: Timing still an issue, even though it is in the
capital account.
Stacy Eastland: 2036(a)(2) should not be applied. O'Malley
case is wrong with all of its progeny. You cannot shift the
income to another partner in a partnership. He agrees with
Porter. Partners have the benefit of the past, present, and
future income. This is language from the Harrison case.
Look at his article (Special Session Materials) He cites
authority from Jennings v. Smith. He suggests putting in the
partnership agreement specific amounts to be distributed with
no discretion. They have used this in almost every single
partnership. It never hurt them in getting discounts. Also
helpful if you want annual exclusions. Solves the Hackl problem.
Also helps on the 2036(a)(1) problem. Now there is a distribution
that would be inconsistent with the retained interest argument.
We have three years to amend partnership agreements and put
Little Suzy or Little Bobby in charge. Now maybe defined value
clauses may have an even greater importance. (He commented
he will talk about defined value clauses in his special session
tomorrow.)
Mitchell: Is not persuaded by idea that the value is in the
capital account. He cited an Alexander case. Here, the interest
could either go to the daughter or her estate. She could sell
her interest as a vested remainder. The Tax Court held that
the father's ability to move it between the daughter or her
estate was all it took to bring the interest back to his estate.
Porter: He likes to see fiduciary duty PLUS ascertainable
standards on distributions in the partnership agreement.
Mitchell: How does that avoid a 2036(a)(1) argument?
Eastland: It just needs to be a standard that can be defined.
Grove: What about transfer issues?
Eastland: A transfer must be the same thing for 2036 as it
does for 25ll. He does not think the initial transfer to a
partnership is a taxable transfer.
Mitchell: He agrees that you have to have a taxable transfer
to get into 2036(a)(1). Thinks that in the recycling argument
the courts have ignored the cases. Prior cases talked about
bona fide sale did you really get the consideration not was
it a family transfer? Cannot be a transfer for 2036 purposes
if it is not a transfer for gift tax purposes. He thinks that
the Tax Court got it wrong on both issues. He thinks the gift
on formation issue is much more troubling. Is there a connection
between gift on formation and bona fide sale? We say that
there is. He things you should fund the partnerships in such
a way as to avoid that argument. What are the appeals courts
going to do?
Jones issue Is there a gift on formation when a child purchases
or obtains general partnership interests and the father only
gets limited partnership interests? The government argued
a gift on formation. Despite the disproportionate control
rights, the Tax Court found no gift on formation because the
capital accounts were property accounting for the interests
contributed. To avoid the issue completely, provide proportionate
interests in both the general and limited partnership interests
upon formation.
Grove: We need to talk about constraints on rights to designate,
2036(a)(2) planning issues. There was not an independent trustee
in Strangi as in Byrum. There were also corporate realities
on Byrum. Also the fiduciary duty in Strangi was owed to himself
since he had 99.9% ownership, whereas in Byrum there was the
possibility of enforcement from others. Byrum refers to the
independent trustee who has the right and the duty to hold
Mr. Byrum responsible. He thinks the idea of an irrevocable
trust with an independent trustee is a powerful tool we can
use for planning.
Looks at his materials, Exhibit 6-B. Three circles surrounding
the designation of donees. First ring is the GPs fiduciary
duty. Second ring is business objectives and economic realities.
The partners should monitor the economic results of the partnership
on an ongoing basis. If the family has had a business plan
and evaluated performance based on the business plan, he thinks
it would have helped in litigation.
Porter: The more it looks like a going concern, the better
and the more likely it is to be respected by the Service.
In the bad cases, the courts have felt like it was not a real
deal. In Stone, the court found there was real business purpose.
Third circle: Distribution authority restrictions. Is the
family lawyer or family accountant an independent trustee
that would help? He thinks the family lawyer or accountant
is more of a subordinate than an independent trustee. He also
thinks expertise is critical as well. Also the facts are important.
Look at the reality of the situation.
Porter: Looks at things backwards because he does not plan...he
litigates. He likes the idea of someone more independent rather
than anyone who could be considered subordinate.
Grove: In Byrum, the decedent had the power to remove the
trustee but the court still liked it. The court said that
if the successor trustee is going to succeed to the rights
of the one removed, then it seems to be OK that you can remove
the independent trustee.
Discussed what the IRS is alleging in its notice of deficiency
on a 2036(a)(1) case. If they argue that you have a retained
right, then the asset that corresponds to your percentage
interest should go back to your estate. If they argue that
an implied agreement exists with regard to all of the assets,
(Harper, Thompson, Strangi), then everything is going to be
included. in the estate. For a 2036(a)(2) argument, if there
is the right to designate, then all assets are going to be
includable.
Porter: Tried two cases recently (November 2003), Vassler
and Bonguard. The Service tried to bring all the assets back
to the estate. They backed out all the gifts made during life
and backed out of the notice of deficiency the fair market
value of the partnership interest. They looked at it as though
no partnership was ever created and no gifts were ever made.
In essence, when 2036 is asserted, the value of the assets
contributed by decedent are brought back in, gifts and partnership
interest are backed out.
Porter: Look at the situation where the general partner has
discretionary authority to distribute, but he is clean with
regard to 2036(a)(1). First go to argument that there was
no transfer, then get to full and adequate consideration,
fully created capital accounts, the partners have received
appropriate interests in the partnership, and satisfy the
bona fide sale rule. With 2036(a)(2) he would take the position
that they are subject to fiduciary duties and that those obligations
are enforceable. They are real obligations because the capital
accounts are required to be credited with partnership funds
that are accrued but not distributed. Given a choice, he prefers
to see some type of mandatory distribution if Mom or Dad is
the general partner. He cannot go along with the Idea that
just because Mom or Day can vote with others to liquidate
the entity, they have a 2036 issue. He does not really think
that can be the law of the land. If so, Bill Gates would have
a 2036 problem with his Microsoft stock because he can vote
with all the other owners of Microsoft stock regarding liquidation.
Grove: What about not making any changes to the way you are
doing anything with respect to the 2036(a)(2) issues. There
are very knowledgeable attorneys who are taking this position.
We do not want to be Chicken Little or the Ostrich with its
head in the sand. Look at everything and make your best call.
2036(a)(2) issue assessment. Exhibit 7 from his materials.
Helps you assess various factors from weak to strong in your
situation. He goes through this analysis with clients and
then makes a mutual decision as to what steps to take. Client
may want to risk the 2036 issue rather than give something
up.
Exhibit 8(a). Strangi II issues where 2036(a)(2) now seems
to apply. Most of the interests have been gifted to already
to the children. His next exhibit adds an independent trustee
to the situation which arguably can take it out of the 2036(a)(2)
problem. If the donor is old, worry about the three year rule
because of possible lapsed or relinquished rights and donor
dies within 3 years. His next exhibit is a different variation
when kids enter into a transaction can either sell a significant
interest or gift a significant interest to charity.
Recommends a Journal of Taxation article by Joe Kirpix where
he discusses the issue of what is a de minimus amount? It
is all relative.
Porter: From a litigation perspective, he likes to see more
rather than less. A legitimate pooling of both assets and
services is the best. In Stone, the children contributed much
more in services. The more it looks like a real deal, a real
pooling of assets and services, the better chance you have
of surviving a 2036 attack. He likes to see children involved
in the process regarding how the partnership is going to be
structured. He has seen the government questioning witnesses
in the Bonguard case right after Stone, and their questions
went to the issue of negotiation in the partnership agreement.
He thinks it does not have to be a fight, just give everyone
the opportunity provide input.
Grove: References to other planning ideas in the Gans Blattmachr
Article. It goes into some detail on an approach where there
can be a restructuring of the FLP when all rights regarding
distribution and liquidation are in the GP interest, and then
there is a gift to an incomplete gift trust.
Porter: Wants to mention some of the IRS attacks on the sale
to a defective trust. The Service ignores the promissory notes
and argues 2701 and 2702. The Service has sought to ignore
the transaction and ignore the notes. A recent case he is
aware of settled nicely. The Service dropped most of their
arguments. But the same things apply. The sales and promissory
notes need to be structured as real deals. Page 51 of his
outline discusses the facts and circumstances the Service
will look at to see if they respect these deals for tr5ansfer
tax purposes. He discusses some tips there as well.
Question: The entity is an LLC, and Mom or Dad gave most
or all of their interest away already but want to stay on
in an investment advisor capacity, but not with regard to
distributions. Will that work?
Grove: Thinks that can be workable. It is only the right
to designate income or property that is hooked by 2036(a)(2).
One of the main arguments in Byrum was that Byrum's right
to control the Board by virtue of his majority interest was
tantamount to his right to retain or distribute income. The
court said no, just because you have impact on investments,
just because you can say do not sell the stock out of the
trust, and just because indirectly you could affect the amount
of income that came to the trust, since you do not have the
right to make the distribution decision, you do not have a
2036(a)(2) issue.
Grove: 2038 issue right to amend or revoke. Also cannot not
have the right to amend or revoke, but investment power is
fine. Cannot have the right to amend or revoke, or to distribute
or liquidate.
Grove read a note from Willamette Management Associates that
said that having a minimum distribution right in the partnership
agreement does not hurt your discount. This right is similar
to rights contained in the commercial entities which are being
used as comparables in the discount appraisals.
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