Estate of Fields v. Commissioner, T.C. Memo. 2024-90 (Sept. 26, 2024) (Copeland, J.), provides a textbook example of a “bad facts” family limited partnership (FLP) that caused estate tax inclusion of the property transferred to the FLP under both sections[1] 2036(a)(1) and (2) with loss of discounts for lack of control and lack of marketability. In doing so, the court applied the Tax Court’s 2017 holding in Estate of Powell v. Commissioner, 148 T.C. 392 (2017)—that the ability of the decedent as a limited partner to join together with other partners to liquidate the FLP constitutes a section 2036(a)(2) estate tax trigger—and raises the specter of accuracy-related penalties that may loom where section 2036 applies.

Facts

Anne Milner Fields inherited an oil business when her husband passed away in the 1960s. She ran that business well and, over time, became a successful businessperson. She took a particular interest in her great nephew, Bryan Milner, whom she educated, mentored, and designated as the successor to her wealth. In her later years, she relied on Milner to take care of her and manage her assets, entrusting him with a general durable power of attorney. Milner ultimately exercised this power of attorney to implement an estate plan involving a FLP about a month before Fields’s death on June 23, 2016.

On May 20, 2016, Milner formed AM Fields Management, LLC (AM Fields Management), of which he was the sole member and manager. He then formed AM Fields, LP (AM Fields) on May 26, 2016, for which AM Fields Management was the general partner and Fields was the limited partner. In forming AM Fields, Milner signed the partnership agreement both as the manager of AM Fields Management and as Fields’s agent under her power of attorney with respect to her limited partner interest. Afterward, he used his power of attorney to transfer to AM Fields approximately $17 million of Fields’s personal assets (constituting more than 85% of her wealth). Of the assets transferred, more than $15.3 million consisted of marketable securities, with the balance comprised of land and interests in closely held entities. He also caused AM Fields Management to contribute $1,000 to AM Fields as its capital contribution. In exchange for the partnership contributions, Fields received a 99.9941% limited partner interest in AM Fields, and AM Fields Management received a 0.0059% general partner interest.

After Fields passed away, Milner obtained an appraisal of Fields’s limited partner interest in AM Fields. The appraiser valued the interest at $10.8 million as of Fields’s date of death, reducing the approximately $17 million in assets that she contributed to the FLP approximately one month before her death by a 36.25% aggregate discount for lack of control and marketability. As the executor of Fields’s Estate, Milner reported this discounted value on the Estate’s Form 706 estate tax return.

The IRS audited the estate tax return and attacked the claimed discount under section 2036(a)(1) and (2). In a Notice of Deficiency, the IRS asserted that section 2036(a) applies such that the gross estate includes the full date-of-death value of Fields’s assets that were contributed to AM Fields without any discount for lack of control or marketability. The IRS also asserted an accuracy-related penalty against the Estate under section 6662(a) and (b)(1) due to negligence or disregard of rules or regulations. Litigation in the Tax Court followed.

Section 2036 Analysis

The Tax Court observed that there are three requirements for property to be included in the gross estate under section 2036(a).[2] First, the decedent must have made an inter vivos transfer of property (which was undisputed here). Second, the decedent must have retained an interest or right specified in section 2036(a)(1) or (2) in the transferred property that he or she did not relinquish until death. Third, the transfer must not have constituted a bona fide sale for adequate and full consideration.

Retained Interest Under Section 2036(a)(1)

The court had little difficulty finding that Fields retained an interest in the property she transferred to the FLP under section 2036(a)(1). As a result of Milner’s dual role as attorney-in-fact under Fields’s power of attorney and as the manager of the general partner, Fields effectively held the right to virtually all the income from her transferred assets, and the AM Fields partnership agreement constituted an express agreement to that effect. In addition, the court found an implicit agreement between Milner and Fields that he, as manager of AM Fields’s general partner, would make distributions from the partnership to satisfy her expenses, debts, and bequests, if any, when necessary. Using a significant portion of partnership assets to discharge obligations of a decedent’s estate [including bequests and estate taxes] is evidence of a retained interest in the assets transferred to the partnership. Virtually nothing beyond formal title changed in the decedent’s relationship to her assets. The $1,000 general partner interest that AM Fields acquired in the FLP was considered de minimis by the court and did not give rise to a pooling of interests to potentially alter this result.

Retained Right to Designate Enjoyment of Property Under Section 2036(a)(2)

Relying on Estate of Powell v. Commissioner, 148 T.C. 392, 402 (2017), the court then held that estate tax inclusion was also triggered under section 2036(a)(2) by Fields’s retention of the right, as a limited partner, to act in conjunction with the general partner to dissolve the FLP and cause its liquidation. As in Powell, the court took a literal construction of the language of section 2036(a)(2), which taints “the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.” (Section 2036(a)(2) (emphasis added))

Bona Fide Sale Exception to Section 2036 Not Available Under These Circumstances

The court next considered whether section 2036’s exception for transfers constituting a “bona fide sale for an adequate and full consideration in money or money’s worth” might spare the taxpayer from section 2036’s reach. The invocation of this exception to section 2036 requires a full and adequate consideration for the inter vivos transfer and a “bona fide sale.” The bona fide sale prong, in turn, requires a “substantial nontax purpose”—as the court put it, an objective determination by the finder of fact as to what, if any, nontax business purpose the transfer was reasonably likely to serve at its inception. The objective evidence must indicate that the nontax reason was a significant factor that motivated the creation of the family limited partnership. A significant purpose must be an actual motivation, not a theoretical justification. The decedent’s age and health at the time of the transfer may be considered for this purpose.

Relying principally on Milner’s testimony, the Estate argued that there were four substantial nontax purposes behind Fields’s capital contributions to the FLP:

1. The FLP protected Fields from further instances of financial elder abuse (which she had sustained several years earlier).
2. The FLP allowed for succession management of assets by permitting Milner to designate his successor.
3. The FLP resolved concerns that third parties, such as banks, may refuse to honor Fields’s power of attorney (which had occurred several years earlier).
4. The FLP allows for consolidated and streamlined management of assets.

The court found Milner’s testimony—that Fields was motivated by any of the above four objectives to contribute her assets to the FLP—not to be credible. Rather, the court found the establishment of the FLP to be motivated by the desire to save estate taxes. Particularly telling was an email from Milner’s attorney to the appraiser who inquired about “obtaining a deeper discount” for tax purposes. Further, the timeline for the establishment and funding of the FLP coincided with Fields’s precipitous decline in health; she suffered from severe Alzheimer’s and died approximately one month after the partnership was funded. In addition, the transfers of assets to the FLP depleted Fields’s liquidity to the point that the Estate could not pay Fields’s bequests under her Will or its estate tax liability without receiving substantial distributions from the FLP. In light of these circumstances, the court determined that “it seems more likely that the four putative nontax purposes are post hoc ‘theoretical justifications’ rather than ‘actual motivations.’” The Estate, therefore, failed to meet its burden of proof that the transfers to the FLP constituted bona fide sales to qualify for the exception to Section 2036.

The Amount of the Section 2036 Inclusion

The court then addressed the amount of the section 2036 inclusion and relied upon the Estate of Moore, T.C. Memo. 2020-40 (2020) for its analysis. Under Moore, one must consider the date of death value of both the limited partnership interest (under section 2033) and the transferred partnership property (under section 2036), and then offset against it under section 2043(a) the value of the transferred property as of the date of transfer. Because neither party argued that there was appreciation or depreciation in the value of the transferred property between the date of transfer and the date of death, the section 2033 and section 2043(a) components canceled each other out, producing estate tax inclusion of the date of death value of the transferred property without any discount.[3]

Accuracy-Related Penalty

Finally, the court reviewed the IRS’s imposition of a 20% accuracy-related penalty under section 6662(a) and (b)(1) on the underpayment of estate tax required to be shown on the estate tax return due to either negligence or the disregard of rules or regulations. Section 6662(c) provides that the term “negligence” includes any failure to make a reasonable attempt to comply with the Code, and the term “disregard” includes any careless, reckless, or intentional disregard. In addition, section 6664(c)(1) provides that “[n]o penalty shall be imposed under section 6662 . . . with respect to any portion of an underpayment if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion.” The Estate bears the burden of proof regarding the reasonable cause defense.

The Estate argued that Milner, in his capacity as executor, had reasonable cause for any underpayment and acted in good faith in determining the Estate’s estate tax liability. The court rejected this assertion because Milner never contended that he personally considered, researched, or understood the implications of section 2036 upon the Estate’s estate tax liability. As the court put it, “a reduction of approximately $6.2 million in the Estate’s reportable assets thanks to the seemingly inconsequential interposition of a limited partner interest between Fields and her assets on the eve of her death would strike a reasonable person in Milner’s position as very likely too good to be true.” (emphasis added) Moreover, the record did not show that Milner relied in good faith on an adviser’s judgment in discounting the value of Fields’s limited partner interest without considering the application of section 2036. The Estate, therefore, failed to meet its burden of establishing reasonable cause and consequently was liable for the 20% accuracy-related penalty on the underpayment of estate tax.                                   

Kevin Matz, CPA, JD, LLM, is a private-clients, trusts and estates partner in the New York City office of ArentFox Schiff LLP, where he co-chairs its Family Office Group. Kevin is currently the President-elect on the Society’s Board of Directors and currently chairs the NYCPA Estate Planning and Private Wealth conferences, the NYCPA Professional Liability Insurance Committee and the Foundation for Accounting Education (FAE) Curriculum Committee.