Valid Transfers Excluded from Gross Estate
Under IRC section 2036(a) and Treasury regulations section 20.2036-1(a) there are two exceptions that prevent transfers from being included in a decedent's gross estate. First, if a transfer is a bona fide sale for adequate and full consideration, it is not part of the gross estate. Second, the transfer also can avoid inclusion if the decedent did not retain possession, enjoyment or rights to the transferred property or the right to designate who would possess or enjoy the property. In 1991 Ruth Kimbell transferred the bulk of her estate to a revocable living trust. In January 1998 the trust and Mrs. Kimbell's son David and his wife formed a limited liability corporation (LLC) with the trust holding a 50% interest. David was the LLC's sole manager. Later that month, the trust and the LLC formed a limited partnership (LP) to which the trust contributed $2.5 million, receiving a 99% limited partnership interest. The LLC contributed $25,000 and received a 1% general partnership interest. At the LP's reception, approximately 11% of the assets were working interests in oil and gas properties. On March 25, 1998, Mrs. Kimbell died, leaving a will. In December her estate filed a federal estate tax return claiming a 49% discount on the value of Mrs. Kimbell's interests in the LP and LLC based on lack of control and marketability, of the LR The IRS subsequently audited the Kimbell estate, determining that the transfers to the LP and LLC were subject to section 2036(a) and that the value of the assets transferred should be included in the gross estate. The estate paid the additional tax and filed liar a refund. A district court agreed with the IRS determination and the estate appealed the decision to the Fifth Circuit Court of Appeals. Result. For the taxpayer. The Fifth Circuit first determined the transfer to the LP (by far the larger and more important) was for full and adequate consideration. To reach this conclusion, the court focused on three main points: (1) the trust and LLC received partnership interests proportionate to the assets each contributed; (2) the partnership accounts were properly credited; and (3) the partnership agreement required distributions on termination or liquidation according to the partner's capital balances. The Fifth Circuit then determined the transfer to the LP was a bona fide sale based on four factors: (1) Mrs. Kimbell had had sufficient assets outside the partnership to support her personal needs; (2) all partnership formalities were satisfied and the transferred assets were actually assigned to the partnership; (3) most of the assets transferred did require active management; and (4) non-tax-objective business reasons existed for the transfer to a partnership that the trust could not satisfy. …