Gifted limited partnership interests brought back into gross estate

Don’t expect to minimize estate taxes by simply funding a limited partnership with marketable securities. That’s the message from a recent United States Tax Court opinion[1]. There, a limited partnership was formed with an LLC as the 0.1 percent general partner. Decedent transferred about $6 million in marketable securities to the limited partnership in exchange for a 99.9 percent limited partnership interest and the membership interest in the LLC.

On the same day as the formation, Decedent’s two sons purchased from Decedent all of her membership interest of the general partner for about $3,000 each without any discounts. Decedent also that day gifted a 10 percent limited partnership interest to an irrevocable trust. Decedent may have expected that the gifted 10 percent limited partnership interest would be outside her gross estate and that the remaining 89.9 percent limited partnership interest would be entitled to valuation discounts.

Indeed, on the estate tax return the 89.9 percent limited partnership interest was reported with a valuation discount of about 33.6 percent. However, the estate tax return was selected for audit and the IRS determined a deficiency. The Tax Court ruled that the entire limited partnership interest was includible in the gross estate without any valuation discounts pursuant to IRC §2036 even though Decedent had other substantial assets.

Section 2036 provides that a decedent’s gross estate includes the value of all property that the decedent transferred but retained the possession or enjoyment of for the decedent’s life. Here, Decedent transferred her marketable securities to the limited partnership and the Tax Court determined that she retained the possession of the property because there was an implied agreement that if Decedent needed money the partnership would have made a distribution to her.

A better plan would be to fund a limited partnership and gift the entire interest during life. In this way, the partnership interest is not reported on the estate tax return. Further, Section 2036 should not apply because the decedent never retains any actual interest in the limited partnership.

The lesson here is that estate taxes can be minimized but proper planning must be implemented to survive an IRS challenge.

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.

Client Alert authored by: David B. Shiner, Principal