Eighth Circuit to Estate of Korby: "Not So Fast."
Why, when certain circumstances are present, the assets in a family limited partnership can be included in the decedent's gross estate.
Section 2036 of the Internal Revenue Code provides:
"The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer…by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death…the possession or enjoyment of, or the right to the income from, the property."
In Estate of Korby v. Commissioner of Internal Revenue, the Eighth Circuit Court of Appeals held that this provision can, in certain circumstances, also apply to family-created limited partnerships.
In Korby, a married couple created a limited partnership and funded it with a total of $1,888,704.00 worth of assets. The couple’s living trust obtained a 2% general partnership interest, while the couple itself obtained a 98% limited partnership interest. The couple proceeded to gift their 98% limited partnership interest to four irrevocable trusts created for their sons. When both husband and wife passed away, neither estate tax return included the value of the estate assets that had been transferred to the partnership, and the IRS issued notices of deficiency as to both of the estates. The IRS argued that the full value of the partnership assets was includable in the gross estate because the couple had retained "for their lives ‘the possession or enjoyment of, or the right to the income from, the property." The Eighth Circuit Court of appeals agreed with the IRS’s position.
How did the court reach this conclusion?
The answer lies in whether the transfer of assets to the partnership constituted a "bonafide sale for an adequate and full consideration in money or money’s worth." If it did, it would have been excluded from the gross value of the estate. However, the Eighth Circuit found that in the case of Korby, there was no such bonafide sale, because even after transferring the assets to the partnership, and then gifting 98% of the interest in the partnership to irrevocable trusts for their sons, the partnership continued to make distributions, whenever the couple requested, to the couple’s living trust.
In reaching its conclusion, the court noted the lack of a written management contract between the living trust and the partnership, the couple’s failure to keep track of the time they spent managing the partnership, and the couple’s failure to report the payments they received from the partnership as self-employment income. In fact, the Eighth Circuit agreed with the finding of the lower tax court that an implied agreement existed between the couple and their four sons that after the assets were transferred to the partnership, income from the assets would continue to be available to the couple for as long as they needed income. Especially important to the tax court, and to the Eighth Circuit, was the fact that the partnership made payments to the couple whenever they requested, rather than according to any sort of set schedule. An additional red flag identified by the court was the fact that the couple, who were both in poor health and could have expected to incur significant living expenses beyond what their Social Security would cover, retained less than $10,000.00 in assets in their living trust, which was their only source of income.
All of these factual considerations, when taken as a whole, led the Eighth Circuit to uphold the tax court’s opinion that the transfer of assets to the partnership was not a bonafide sale for adequate consideration under 26 U.S.C. § 2036(a), but rather, that the couple had essentially stood on all sides of the partnership’s formation.
For an excellent discussion of other recent cases dealing with family limited partnerships, see this Florida Bar Journal article by David Pratt, Trent S. Kiziah, and John F. Pokorny.
