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CARELESSNESS THWARTS AN ESTATE PLANNING PLOY

January 09, 2006

Mark Senda went to an estate planning seminar sponsored by Arthur Anderson, of blessed memory. There he learned how family limited partnerships can do wonderful things to reduce your esate tax potential. He pondered this for awhile, while in the meantime coming into a small fortune in MCI/Worldcom stock.

Things got serious around December 28, 1998. On or about that day, Mr. Senda contributed $1,798,647 worth of MCI/Worldcom into a family limited partnership, and at about the same time he gave away all of his interests to his children. He then filed a gift tax return claiming a combined marketability and minority discount for the gifts of 38.82%. This discount is the whole point of the family partnership game.

He liked the results so much that he did the same thing with another $791,826 of MCI/Worldcom on December 20, 1999, using a new partnership, claiming a 45% discount, and then another $164,103 in January 2000, using a $46.13% discount.

PAPERWORK MATTERS

Unfortunately for Mr. Senda, he was a bit sloppy with his paperwork. For the 1998 and 1999 gifts, it wasn't clear that he gave the partnership interests away before he put the stock in the partnership. The IRS said that these two gifts were really just stock gifts, and that no partnership valuation discounts could be allowed. The Tax Court agreed with the IRS.

Mr. Senda appealed to the Eight Circuit. On Friday, they upheld the IRS and the Tax Court, saying, in effect, that the paperwork around the gifts was just too sloppy. They quote with approval this passage from the Tax Court opinion:

It is apparent from petitioner's evasive testimony and from the total record that petitioners were more concerned with ensuring that the beneficial ownership of the stock was transferred to the children in tax-advantaged form than they were with the formalities of FLPs. Indeed, petitioner, as general partner, did not maintain any books or records for the partnerships other than brokerage account statements and partnership tax returns. Those tax returns were prepared months after the transfers of the partnership interests. Thus, they are unreliable in deciding whether petitioners transferred the partnership interest to the children before or after they contributed the stock to the partnerships. The same is true of the certificates of ownership reflecting the transfers of the partnership interests, which were not prepared until at least several weeks after the transfers. The informality is not surprising, inasmuch as petitioners alone, individually, or on behalf of their minor children were united in purpose and acted without restraint by any adverse interest. As a result, however, petitioners have presented no reliable evidence that they contributed the stock to the partnerships before they transferred the partnership interests to the children. At best, the transactions were integrated (as asserted by respondent) and, in effect, simultaneous.

Interestingly, the 46% discount for the smaller gift in January 2000 was allowed. It was clear from the record that the partnership had held the stock for at least 20 days before the partnership interest gifts were made, so the court didn't collapse the contribution of stock and the gift of partnership interests into a single transaction.

The Moral? The Eighth Circuit covers Iowa. This case would appear to show that family partnership discounts work here, but that formalities matter.

Of course, Mr. Senda violated another important estate planning rule of thumb (surely unintentionally): give away assets that are going to increase in value. Remember, Mr. Senda made his gifts in December 1998, December 1999 and January 2000. Here's a chart of the performance of the WorldCom stock:

Lets hope the partnerships sold out. If there's any worse tax planning result than paying the $646,000 in tax because you were careless with your paperwork, it's paying it for giving away shares that quickly became worthless.

Links:

Eighth Circuit decision

Tax Court opinion

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