Letting Go: Common Gift & Estate Tax Triggers

It is the season of giving which ultimately fuels the season of estate and gift tax audits.

Many of the questions raised in an audit can be anticipated by prior cases, such as: review of the decedent's background, lifestyle, gifts and assets (Estate of Harper, TC Memo 2002-121); information about the donor's heath, intent and entity operation (Estate of Rosen, TC Memo 2006-115); the order in which transactions occurred (Estate of Shepard, 115 TC 376 (2000), aff'd 283 F3d 1258 (11th Cir. 2002)); and information about meetings with the client(s) and the reason for the entity, the manner in which business responsibilities were assumed, and the documentation of legitimate non-tax reasons (Estate of Rosen, TC Memo 2006-115). One of the common gift or estate tax audit triggers occurs when a family limited partnership (FLP) or a limited liability company (LLC) is involved. This is because these entities are utilized by donors who may not completely understand the risks associated with planning with these entities or who demand continued control. The result is that the Internal Revenue Service may claim the estate retained certain enumerated rights over the entity, and pursuant to §2036 of the Internal Revenue Code, the full value of the transferred asset should be included in the estate at the date of death value, not at a discounted value.

That is why Estate of Purdue v. Commissioner, TC Memo 2015- 249, stood out—because it bucked the typical scenario. In this case, the decedent and her husband in August 2000 formed a family limited liability partnership (PFLLC) to hold their marketable securities and their interests in a commercial building to centralize management and take advantage of valuation discounts. As set forth in the memorandum prepared by their attorney, the purposes of the FLP was (1) to consolidate their assets, (2) avoid fractionalization of their interests, (3) keep the ownership in the family, (4) protect assets, (5) provide flexibility and (6) promote education of and communication among the family with respect to financial matters.

The day after the FLP was formed, the family, including all five children received a draft Purdue Family Limited Liability Company operating agreement from this same attorney noting the tax savings the FLP could provide as well as four non-tax business reasons for the formation of the FLP. In November 2000 the FLP was funded. In the same month, the decedent and her husband also formed a family trust...