In Stone v. Commissioner, the Tax Court ruled in favor of the taxpayer when the IRS sought to attack the favorable estate tax consequences of a family partnership under Code §2036(a). Code §2036(a) will result in gross estate inclusion for transferred property when the decedent retains income rights or dominion and control over the property. However, Code §2036(a) will not apply if the transfer was a bona fide sale for adequate and full consideration.
This exception can be broken down into two elements – (a) a bona fide sale, and (b) adequate and full consideration. The short story on this case is that absent bad facts, the presence of a legitimate and significant nontax purpose for the partnership will allow both (a) an (b) to be satisfied, at least under this interpretation of Code §2036.
Key points of this case are:
A. In context of FLP transfers, the requirement of a “bona fide” sale is met if there is a legitimate and significant nontax reason for the transfer.
1. Use of a limited partnership to facilitate ease of gift giving may not be enough of a nontax reason for this requirement.
2. A desire for joint management of assets by family members can be an adequate nontax reason.
3. A desire to avoid partition of an asset can be an adequate nontax reason.
4. Per the enumeration of six listed “bad” factors, good or bad facts may sway the decision on whether an otherwise adequate reason will be deemed a legitimate and significant nontax reason. These six factors are: (1) the taxpayer standing on both sides of the transaction; (2) the taxpayer's financial dependence on distributions from the partnership; (3) the partners' commingling of partnership funds with their own; (4) the taxpayer's actual failure to transfer the property to the partnership; (5) discounting the value of the partnership interests relative to the value of the property contributed; and (6) the taxpayer's old age or poor health when the partnership was formed. Importantly, the case confirmed that presence of some of these facts will not be determinative. In the Stone case, (1) was present since the transferors were the former owners and also general partners of the recipient partnership, and that was not fatal to the use of this Code §2036 exception. Interestingly, and perhaps importantly for the court, there were no gift tax discounts taken when the partnership interests were transferred by the funding parents to gift recipients.
B. In context of FLP transfers, the Tax Court’s “recycling of value” theory continues to be applied, as to whether adequate and full consideration exists. However, in regard to this theory, the court determined that a legitimate nontax purpose for the transaction was enough to escape a mere “recycling of value” finding that would prevent a finding of adequate and full consideration. Note that this method of analysis is significantly different from that applied in Bongard and Kimbell.
Stone v. Commissioner, TC Memo 2012-48