Report No. 6 (Tue. 1/15)
As we have done in January for the last eleven years, and again with the
permission of the University of Miami School of Law Center for Continuing
Legal Education, we will be posting daily Reports to this list containing
highlights of the proceedings of the 42nd Annual Philip E. Heckerling
Institute on Estate Planning that is being held January 14-18, 2008 at the
Orlando World Center Marriott Resort and Convention Center in Orlando,
Florida, a new venue for the Institute starting in 2007. A complete listing
of the proceedings will be published here and is also available on the
Institute's Web site at http://www.law.miami.edu/heckerling.
We also will be posting the full text of each of these Reports on the ABA
RPPT Section's Web site, as we have since the 2000 Institute. Those Reports
can be found at URL http://www.abanet.org/rppt/meetings_cle/heckerling. In
addition, each Report can also be accessed at any time from the ABA-PTL
Discussion List's Web-based Archive at URL
http://mail.abanet.org/archives/aba-ptl.html.
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This Report covers Current Valuation Issues Involving FLPs and LLCs and
What Do I Do With My Stuff from the Tuesday sessions. The next Report will
cover even more of the Tuesday sessions.
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A NEWS ALTER Courtesy of the LISI News Service:
Steve Leimberg's Estate Planning Email Newsletter - Archive Message #1226
Date: 16-Jan-08
From: Steve Leimberg's Estate Planning Newsletter
Subject: FLASH Knight Affirmed 9-0
Ronald D. Aucutt just informed LISI that the Supreme Court has affirmed the
Court of Appeals Knight decision, by a 9 to 0 Opinion by Chief Justice Roberts.
"Accordingly, we conclude that the investment advisory fees incurred by the
Trust are subject to the 2% floor."
LISI is posting the decision in our ActualText archives and we'll be
reporting on it further as soon as possible!
A copy of the decision is available at
http://www.supremecourtus.gov/opinions/07pdf/06-1286.pdf
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Current Valuation Issues Involving FLPs and LLCs
Tuesday, January 15, 2008
Presenter: John Porter
Reporter: Mike Stiff
John Porter's materials included a detailed 84 page outline and a sample
IRS audit letter as Exhibit 1. The IRS audit letter provides an example of
the range and scope of information commonly requested by the IRS when a
family limited partnership or other closely held business organization is
involved.
Mr. Porter's 50 minute presentation focused primarily on what he personally
is seeing in FLP (and LLC) audit and litigation cases with the IRS. Since
the early 90s, the IRS has been in a full court press in challenging
FLPs. There are basically 5 arguments being made by the IRS to attack FLPs.
1. The Murphy Argument. The Murphy argument is that the FLP lacks
economic substance and should be disregarded. This substance over form
argument comes from the Tax Court's memorandum decision in the Estate of
Murphy and was the initial argument made by the IRS to attack
FLPs. However, the courts were reluctant to disregard the existence of a
validly created entity under state law where there were valid non-tax
reasons for creating the entity. Mr. Porter indicated that while this
argument may still arise at the examining agent level, he is not seeing
this argument being made at the appeals level.
2. I.R.C. Section 2703 Argument. The Section 2703 argument is that the
partnership agreement itself is a "restriction on the right to sell or use"
the property and therefore should be ignored for valuation purposes. Mr.
Porter indicated that he is not seeing this argument being made by the IRS
except to attack specific buy/sell agreement provisions contained in
partnership agreements. This is consistent with the purpose of Section
2703 and then leads to the analysis of whether the provision in question
falls into the exceptions under Section 2703(b). To fall into the exception
under Section 2703(b), the option, agreement, right or restriction must
satisfy 3 requirements: (1) It is a bona fide business arrangement; (2) it
is not a device to transfer such property to members of the decedent's
family for less than full and adequate consideration in money or money's
worth; and (3) its terms are comparable to similar arrangements entered
into by persons in an arm's length transaction. The key issue usually is
the third requirement of comparability. The taxpayer needs to show such
provision is comparable to similar arrangements. As to price, the
provision normally will need to require fair market value as opposed to
book value. Mr. Porter is seeing less and less business arrangements that
use book value as the standard of value. As to terms, a promissory note
for a reasonable term is very common. As to interest rate, the question is
whether the applicable federal rates ("AFRs") are sufficient or whether it
should be at a commercial rate. The AFR rate should be sufficient but the
commercial rate may give greater comfort. Mr. Porter pointed out that
usually even if you fail to fall into the exception, the application of
Section 2703 to ignore the buy/sell restriction usually does not have a big
affect on value since you are still valuing a non-marketable, minority
interest in the FLP.
3. I.R.C. Section 2704(b) Argument. The Section 2704(b) argument is that
any applicable restrictions should be ignored for valuation purposes. An
applicable restriction is any restriction that is more restrictive than the
defaults rules under state law. As with the earlier arguments, this
argument did not find judicial support and is not being made by the IRS on
a regular basis.
4. Gift on Formation Argument. The gift on formation argument was based
on the IRS depletion theory. If the value of the partnership interest
received by a partner was less than the value of the assets contributed,
then a gift must have been made to someone. The question is to who has the
gift been made and where is the necessary transfer required for
taxation. This argument was basically dead but has resurfaced in the bad
formation and indirect gifts cases such as Shepard and Senda. In Shepard,
the father contributed all of the property to the partnership and gifted
25% to each of his two sons. The Court reasoned that because a partnership
needs at least two partners, the father made indirect gifts of the property
contributed to the partnership, not gifts of partnership interests, to the
children. In Senda, the date of the gift and the date of funding were very
close together. The taxpayer was unable to carry the burden of proof that
the FLP was funded before the gifts were made. Mr. Porter stated that the
gift on formation argument is easy to avoid with good formation facts and
procedures. You want to have clear objective evidence of the formation,
funding and gifting, as well as the order in which each of these events
occurred. Establish and keep capital accounts for each partner, especially
if the boilerplate in your agreement requires it. How long should you wait
between funding and gifting? No bright line test. Mr. Porter currently
has a case were the IRS is making the Senda argument where the gifting
occurred 8 days after funding. The IRS is arguing an indirect gift
occurred because the gift was contemplated upon formation. The preferable
course of action is for the gifting discussions to occur after, and not
before, the formation and funding of the FLP is complete. Although it
shouldn't matter if the gifting occurs only 1 second after funding, it
appears 3 months is better than 8 days, 6 months is better than 3 months
and even better if can wait until next tax year.
5. I.R.C. Section 2036 Argument. The Section 2036 argument has become the
government's silver bullet for attacking poorly formed and operated
FLPs. The outline contains detailed descriptions of the various Section
2036 cases and their specific facts. However, as Mr. Porter emphasized, it
is no one factor or bad fact that is causing inclusion under Section
2036. Conversely, it is the amalgamation of bad facts that supports the
inference of an implied agreement between the senior family members and the
next generation beneficiaries. Some of the common bad facts are
disproportionate distributions, personal expenses being paid from the FLP,
creation immediately before death, contribution of substantially all of the
taxpayer's property, contribution of personal use assets, financial
dependence upon partnership distributions, and post death payment of estate
taxes to name a few. Mr. Porter discussed the bona fide sale exception,
and adequate and full consideration under Section 2036. Mr. Porter also
discussed the facts of recent cases, including Erickson and Rector. Mr.
Porter indicated that even pro rata distributions are being challenged by
the IRS when such amounts are equal to or close to the total income for the
FLP. The 2036 argument is also raised when distributions are made on an as
needed basis to the senior family members. The Section 2036 argument has
been the most successful argument for the IRS to attack FLPs but also
usually requires the presence of several bad facts.
Mr. Porter also discussed various questions arising from the FLP cases.
Consequences of payment of post death expenses and estate taxes from the
FLP? While Mr. Porter believes that what occurs after the decedent's death
should not affect the determination of whether the decedent had a retained
interest, this argument is being made by the IRS to support the inference
of an implied agreement. If the estate does not have liquid resources
outside the FLP, Mr. Porter's preference is to have the estate borrow from
a third party lender. If not possible or feasible, hopefully there is a
family ILIT or other family entity with resources other than the FLP. If
the only source of liquid funds is the FLP, you have three options: (1) a
redemption; (2) pro rata distributions; or (3) a loan from the FLP. The
redemption and pro rata distribution options should be viable options but
may be playing into the hand of the IRS. The IRS has used these facts in
attacking other FLPs in decedents' estates. The loan is probably the
preferable option and should be evidenced by a written promissory note that
carries a reasonable interest rate. You may also want to have the note
secured by the estate assets including the FLP interest and may want to use
a commercial rate as opposed to an AFR rate for greater comfort.
Is it advisable for a taxpayer to serve as one of the general
partners?. Very few cases have specifically addressed this issue and the
results are mixed. Mr. Porter's preference is for the senior family
members to have no general partnership interests at the time of their
death. Better yet if the general partnership interests have been
transferred by the senior family members 3 years before their
death. Drafters also need to be careful that there are reasonable
constraints on the discretion over distributions if senior family members
are serving as general partners. You should avoid distributions being left
to the "sole and absolute discretion" of the general partners. You also
should carefully review the boilerplate provisions of the partnership
agreement that address the liability standards for the general
partners. Mr. Porter doesn't like to see general partners' liability
limited only to criminal acts. You need to be careful in lessening the
fiduciary constraints for senior family members serving as general
partners. As you lessen and slice away the fiduciary constraints, is
anybody left to enforce the general partner's duties to the other partners.
In closing, Mr. Porter stated that if you take one thing from his
presentation today, it should be that planning for the IRS dispute over
FLPs begins at the estate planning level. Most of the IRS arguments can be
avoided with good formation facts and proper operation of the entity. If
it is in the boiler plate provisions of the partnership agreement, then it
should be followed. You want to have a good documentary trail of what
occurred and contemporaneous written evidence and documentation to support
each step. The estate planning attorney's and the client's files should be
peppered with the non-tax reasons for creating the partnership. If you
proffer specific non-tax reasons for the creation of the FLP, then they
should occur in action and deeds, not just in the language of the
agreement. If the non tax reason is to centralize management of the
assets, then these changes in management should occur. If the non tax
reason is to mentor younger generations or to preserve the taxpayer's buy
and hold philosophy, then these also should also occur. Mr. Porter also
indicated that in Section 2036 cases, the estate planning attorney is
usually placed on the stand and is the key witness. Are your actions and
procedures preparing you to be the star witness for your client?
Mr. Porter's presentation was excellent and the personal insights from his
experiences litigating these matters was very informative.
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Picasso, Warhol, Koons - What Do I Do With My Stuff
Tuesday, January 15, 2008
Presenter: Ralph Lerner
Reporter: Ronda Martinez
Is the owner a dealer, investor, or collector? The objective is to be an
investor in order to qualify for the deduction of expenses and losses
allowed for tax reporting purposes.
DEALER: Conducts a trade or business with continuity or regularity to make
a profit.
INVESTOR: Buys, sells, and holds artwork primarily for investment - an
activity for profit.
COLLECTOR: Buys and sells art primarily for personal pleasure, and may not
deduct expenses and losses.
Investment activity is a facts and circumstances test to consider whether:
the collector can establish that the investment purpose for
acquiring and holding the items was "principal";
the items that make up the collection can be a subject of
investment;
the collector intends to hold the property for
investment. Indicators of investment intent include consulting with
experts; reading pertinent publications; devoting time to the collections
and participating in collection-related activities; making a public effort
to enhance the collection's value; keeping business like records.
Further, Section 183 sets forth a number of similar factors to determine
investment activity:
1. manner in which the taxpayer carries on the activity
2. expertise of the taxpayer or his/her advisors
3. time and effort expended on the activity
4. expectation that the assets will appreciate in value
5. success in carrying out other activities for profit
6. income/loss history related to the activity
7. amount of profits earned
8. financial status of taxpayer
9. elements of recreation vs. profit motive
Cleary, the main objective of Section 183 is to disallow deductions
attributable to an activity not engaged in with the expectation for profit.
Certain Internal Revenue Codes allow for deductions and losses: Section
162 permits a dealer to deduct all ordinary and necessary expenses incurred
in a trade or business; Section 212 allows the deductions for expenses
incurred in the production or collection of income; Section 165 allows the
deduction of losses sustained in a trade or business or in a transaction
entered into for profit; Section 1031 allows certain "like-kind", tax free
exchanges. Like-kind exchanges are not available to dealers or collectors.
Section 1031: The general rule is that qualifying property must be
exchanged solely for other qualifying property. There are 4 elements for
the like-kind exchange to be tax-free:
there must be an exchange;
the exchange must be property that qualifies under Section
1031(a);
the replacement must be like kind or similar to the property
exchanged;
the exchanged and the replacement properties must be held for
productive use in a trade or business, or for investment.
The Pension Protection Act (PPA) of 2006 requires a charitable donee to
file tax form 8282 if the donee disposes of the property within 3 years of
receipt of the donated property. This ay cause related use problems for
the donor, but the donor cannot say outright not sell the property within
that time frame because that could impact the actual value of the donated
property.
The PPA revised that definition of "qualified appraiser". It is strongly
recommended that the appraiser adhere to the Uniform Standards of
Professional Appraisal Practice (USPAP).
Fractional gifts were discussed as being no longer desirable. A fractional
gift would be a work of art that resides in the donor's residence. The use
limitation is 10 y ears and has a valuation limitation. Further, the case
of Robert G. Stone v. United States established a 5% discount for undivided
fractional interests in artwork, rather than allowing the 51% requested by
the taxpayer.
Finally, new penalty rules were mentioned that reach preparers and
appraisers.
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THE REPORTERS
Our on-site local reporters who are present in Orlando this year are Gene
Zuspann Esq. of Zuspann & Zuspann in Denver, Colorado; Joanne Hindel Esq.
of Fifth Third Bank in Cleveland, Ohio; Jason Havens Esq. of Howard, Mobley
& Havens PLLC in Florida and Tennessee; Kimon Karas Esq. of McCarthy,
Lebit, Crystal and Liffman Co., LPA in Cleveland, Ohio; Bruce Stone Esq. of
Goldman, Felcoski & Stone, PA in Coral Gables, Florida; Craig Dreyer Esq.
of McDonald Hopkins LLC in Cleveland, Ohio; Carol Sobczak Esq. of The Law
Offices of Carol A. Sobczak in St. Helena, California; Ronda Martinez Esq.
of Fifth Third Bank in Southfield, Michigan; and Mike Stiff Esq. of
Hutchins & Stiff LLC in Denver, Colorado. The editor again this year will
be Joseph G. Hodges Jr. Esq, a solo practitioner in Denver, Colorado, who
also is the Chief Moderator of the ABA-PTL List.
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GENERAL INFORMATION ABOUT INSTITUTE:
Inquiries/Registration:
Philip E. Heckerling Institute on Estate Planning
University of Miami School of Law
Center for Continuing Legal Education
P.O. Box 248087
Coral Gables, FL 33124-8087
Telephone: 305-284-4762 / FAX: 305-284-6752
Web site: www.law.miami.edu/heckerling
E-mail: heckerling@law.miami.edu
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Telephone (407) 239-4200, FAX (407) 238-8777
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NOTICE: Although audio tapes of all of the substantive session at the Miami
Institute currently are only made available to Institute registrants for
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proceedings is also available on CD ROM from Authority On-Demand by
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