============================================== This Report contains some news coverage and additional coverage of the Tuesday sessions on FLPs and GRATS ============================================== 1) Alaska Trust Company, an exhibitor here at the Institute, has informed us that the Trust forms they used to provide on CD-ROM are now available for viewing and download in PDF format from their Web site at http://www.alaskatrust.com. 2) Apropos the discussion of Circular 230 during the Recent Developments presentation on Monday afternoon, ALI-ABA has just announced the following CLE session: The New Circular 230 Regulations: What You Need to Know Wednesday, February 9, 2005, 1:00 - 2:30 p.m. Eastern Join the American Bar Association Section of Taxation for a 90-minute
Teleconfernce and Live Audio Webcast on The New Circular 230 The long-awaited Circular 230 regulations were issued December 17, 2004, and will become effective in June 2005. Learn what you need to know to comply with the new rules from Treasury and IRS officials and private practitioners who have played a significant role in the drafting of these much-anticipated regulations. Our Expert Faculty Register Online Now! 3) Northern Trust reports that it has update its form book The book includes will, trust agreements for one settlor, trust agreements for community property, and miscellaneous forms such as irrevocable insurance trusts, CRUT, CRAT, QDOT and gift trust agreements. The book is available for $250 but includes no disk or CD. An online
product is available for $350 for the first year ($100 renewal)
or $500 for multiple users ($200 renewal). The product is to be
available in February ===================================================== Reporter: Shelly D. Merritt Esq. Mr. Porter gave an in depth update on IRS arguments against FLPs and recent cases affecting the IRS’s position. IRS Arguments Regarding Family Limited Partnerships 1. Substance over form argument (Murphy v. Commissioner). Argument that if the primary purpose for creating the partnership is to reduce transfer taxes, it can be ignored for tax purposes. Recent cases have pretty much eliminated this argument. So long as a partnership meets state law formalities, it is a valid entity for tax purposes regardless of motive (Kerr v. Commissioner and Estate of Strangi v. Commissioner) 2. IRC §2703 Argument. Section 2703 provides that any option, agreement, or other right to acquire or use property at a price that is less than fair market value of the property is disregarded when valuing the property unless it is a bona fide business arrangement, it is not a device to transfer the property to family members at less than full and adequate consideration, and its terms are comparable to similar arm’s length arrangements. The government has used IRC §2703 to argue that the partnership agreement itself is an agreement under 2703 and therefore is disregarded for valuation purposes. The IRS has lost this argument and the cases have held that 2703 cannot be used to ignore completely the existence of the entity agreement itself. It’s purpose is to ignore abusive buy sell agreements. 3. IRC §2704(b) Argument. Section 2704 provides that certain
"applicable restrictions" must be disregarded in determining
the value of a transferred ownership interest if certain requirements
are met. An "applicable restriction" is a restriction
that is more restrictive than state law. In Kerr, the IRS argued
that provisions in the partnership agreement limiting a limited
partner’s right to liquidate was an applicable restriction
under 4. Gift on Formation Argument. The IRS has argued that a gift occurs
when In Senda, the Court found that the parents had actually made a gift of the property contributed to the partnership directly to their children, rather than a gift of limited partnership interests. In this case, the parents made a capital contribution of stock to an existing FLP and on that same day purportedly made gifts of partnership interests to their children (the assignments were not signed until several years later). However, there was no evidence that the contribution was ever actually credited to the parents’ capital accounts. To avoid gift on formation, contributions to a partnership should be credited to the contributing partners’ capital accounts before any transfers of limited partnership interests are made in order to make it clear that the gift is of the partnership interest and not the capital contribution. 5. IRC §2036(a) Argument Elements of Section 2036(a): 1) Transfer by decedent 2) Other than a bona fide sale for adequate and full consideration 3) Under which transferor has retained either: -(a)(1) the possession or enjoyment of, or the right to the income from, the property, or -(a)(2) the right, either alone or in conjunction with another person, to designate the persons who shall posses or enjoy the property. IRC 2036(a)(1) The Service has succeeded using 2036(a)(1) where the facts of the situations are such that the partnership assets are not kept separate from the donor’s assets. Some examples: Commingling of partnership assets with personal assets Contributing personal use assets to the partnership (i.e., contributing a house to the partnership) (Estate of Strangi v. Comm’r) Assets of partnership used to pay personal expenses (Estate of
Thompson v. Government has argued that in the case of an elderly person, there
needs to be enough assets outside of the partnership to pay estate
taxes (Strangi). Section 2036(a)(1) can be avoided by taking precautions to make sure entity is respected. IRC Section 2036(a)(2) Where a senior family member retains a GP interest, the government has argued that he/she has the ability to make distribution decisions which controls who enjoys the benefit of the partnership. Estate of Strangi v. Comm’r: In Strangi, the decedent formed
an FLP with his children and a corporate GP. Mr. Strangi took back
a 99% limited partnership interest and 47% of the 1% corporate GP.
His children owned the remaining 53% of the corporate GP. Mr. Stangi’s
son-in-law managed the day to day affairs of the corporate GP and
the partnership. His son-in-law was also his attorney-in-fact under
a power of attorney. A host of bad facts supported finding that
Section 2036(a)(1) applied. The government also argued that the
son-in-law’s power to control distributions as a manager of
the corporate GP should be imputed to the decedent as his attorney-in-fact.
Kimbell v. United States, 244 F.Supp.2d 700 (N.D. Tex 2003). IRS
successfully argued at the district court level that an FLP should
be ignored under §2036(a)(2), but was reversed on appeal by
the 5th Circuit. To avoid 2036 (a)(2): 1) the partnership agreement should not provide that the GP has
no fiduciary obligations. Both 2036(a)(1) and (a)(2) can be avoided by satisfying the bona fide sale exception. Kimbell Bona fide sale. The 5th Circuit looked at objective facts to determine if the partnership was treated as separate entity, including non tax reasons for creating the entity. The Court seemed to focus on fact that in Kimbell, the decedent owned an 11% working interest which required active management. Therefore a valid non-tax reason existed for the partnership. Adequate and full consideration test. The Court found that so long as the value of assets transferred to a partnership are properly credited to the capital account of the contributing partner, the partner’s interest in the partnership is based on his/her capital account, and the partner receives his/her capital account upon liquidation of the partnership, then this test is met. Estate of Thompson 3rd Circuit affirmed Tax Court’s finding that §2036(a) applied and that bona fide sale exception was not met. Bona fide sale. Court found that there was no non-tax reason for
the creation of the partnership and therefore there was no "bona
fide sale." ============================================================ Presenter: Carlyn S. McCaffrey Esq. Reporter: Herbert L. Braverman Esq. Carlyn S. McCaffrey, who is as well known as any estate planning
attorney in this country, discussed "The Care and Feeding of
GRATs--Enhancing GRAT Performance Through Careful Structuring, Investing
and Monitoring". The "grantor retained annuity trust"
is one of the most powerful, currently available estate planning
techniques. It is a trust that pays an annuity to its grantor for
a specific period of time and then shifts the beneficial interest
to another beneficiary or beneficiaries. It is a "qualified
annuity interest" if its terms satisfy the requirements set
forth in Treas. Reg. 25.2702.3 There are 8 governing instrument
requirements, including: 1. annuity amount must be payable at least
once in every 12 month period to the appropriate payee. The grantor will pay all of the income taxes on earned income of the GRAT; it is a grantor trust when properly prepared. Upon termination, the property of the GRAT is transferred to the remainder beneficiary(s) free of gift tax. Carlyn's primary focus in the presentation was upon enhancing GRAT performance through careful structuring, investment selection and monitoring of GRAT performance over time. She indicated the following structural issues in this regard: 1. Create a GRAT with no taxable gift(s); make the actuarial value
of the annuity payments=the value of the property transferred to
the GRAT. 2. Short term GRAT versus long term GRAT. A shorter term minimizes
the number of years of poor performance by GRAT assets and reduces
the likelihood of grantor's early death during the term of the GRAT.
On the other hand, the 7520 rate could increase dramatically and
hamper the re-GRATTING plan and a change in tax laws could adversely
effect the plan. Longer term GRATs lock in a low interest rate over
a longer term and work well for non-marketable assets without cashflow
. 3. Amount of each annuity payment was considered and it was suggested
that a formula approach might prove best in many cases. Also keep
in mind the use of graduated payments (see her table 5 on page 6-17). 4. Use single asset GRAT. This prevents poor performing assets from diluting good performance of other assets. 5. Use of income tax payment reimbursement clause. Best to make it discretionary for the trustee and to avoid it altogether if local law is a problem. 6. Marital deduction planning. Give grantor the power of appointment to do marital deduction for that portion of the GRAT that would be otherwise includable in her/his estate. 7. Avoid use of spendthrift clause. 8. Identify the remainder beneficiaries, either individual(s) and /or a free standing trust(s). 9. Use a power allowing an independent trustee to amend the trust as necessary. 10. Plan profit level carefully so that remainder beneficiary(s) gets the amount grantor desires as precisely as possible, as long as the property in the GRAT appreciates sufficiently. Selecting investments for the GRAT carefully may enhance the probability of success. Assets mentioned by Carlyn included those with restrictions that provide a basis for discounting the value of the property transferred into the GRAT, assets with limited marketability like fractional shares or non-controlling interests in a family business, certain stock options and derivatives. Monitoring the GRAT plan is also very important. Who will do this? _________________________________________ GENERAL INFORMATION ABOUT INSTITUTE ______________________________________________________ To search the ABA-PTL archives online or manage your subscription,
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