Estate of Concetta H. Rector v. Comm'r , 94 T.C.M. 567 ( 2007 )

T.C. Memo. 2007-367
UNITED STATES TAX COURT
ESTATE OF CONCETTA H. RECTOR, DECEASED, JOHN M. RECTOR, II,
CO-EXECUTOR and CO-TRUSTEE, Petitioner v. COMMISSIONER
OF INTERNAL REVENUE, Respondent
Docket No. 20860-05. Filed December 13, 2007.
Edwin C. Anderson, Jr., Daniel E. Post, and Michael D.
Maciel, for petitioner.
Alan E. Staines, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
LARO, Judge: Petitioner petitioned the Court to redetermine
a $1,633,049 Federal estate tax deficiency and a $92,790
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accuracy-related penalty under section 6662(a).1 Following
concessions, we decide whether Concetta H. Rector (decedent)
retained the possession or enjoyment of, or the right to the
income from, property transferred to Rector Limited Partnership
(RLP) for purposes of section 2036(a)(1). We hold she did.2 We
also decide whether decedent’s estate (estate) is liable for an
accuracy-related penalty under section 6662(a) for failure to
include as adjusted taxable gifts on the Federal estate tax
return prior gifts of $595,000. We hold the estate liable for
the penalty.
FINDINGS OF FACT
1. Preface
Some facts were stipulated and are so found. The
stipulation of facts and the accompanying exhibits are
incorporated herein by this reference. Decedent was a resident
of the State of Nevada when she died testate on January 11, 2002,
at the age of 95. Decedent’s son, John M. Rector II (John
Rector), is coexecutor of decedent’s estate. When the petition
was filed, John Rector resided in Sonoma County, California.
1
Unless otherwise indicated, section references are to the
applicable versions of the Internal Revenue Code, Rule references
are to the Tax Court Rules of Practice and Procedure, and dollar
amounts are rounded.
2
Given this holding, we do not consider respondent’s other
arguments in support of respondent’s determination that the value
of the property is includable in decedent’s gross estate.
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2. Decedent and Her Family
Decedent was born in 1906. She was married to John Rector,
Sr. (Jack Rector). Decedent and Jack Rector had two sons, John
Rector and Frederic Rector. John Rector has been a licensed
investment broker since 1961, and he has managed equity, fixed
income, venture capital, and other investments. John Rector also
holds a securities license, a commodities license, an insurance
license, an options license, and a registered investment advising
license. John Rector was actively involved in decedent’s
finances.
3. Decedent’s Trusts
In 1975, decedent and Jack Rector created a trust. After
Jack Rector died in 1978, the trust was bifurcated into Trust A
and Trust B. John Rector was the investment counselor to Trust A
and Trust B. In that capacity, John Rector managed the
investment portfolio of each trust, recommended transactions to
decedent, and executed the transactions she authorized him to
make. John Rector also was a cotrustee of Trust A and Trust B.
Decedent was the other cotrustee of Trust A, and Frederic Rector
was the other cotrustee of Trust B.
The property transferred to Trust A was decedent’s share of
the community property from her marriage, decedent’s separate
property, and one-half of Jack Rector’s gross estate. Decedent
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was entitled to the income and principal of Trust A and had a
power of appointment with respect to its remainder.
The property transferred to Trust B was Jack Rector’s
remaining assets. Decedent’s interest in Trust B was a life
estate, consisting of distributions of monthly income. The terms
of the Trust B agreement directed that the cotrustees make
monthly payments of the net income to decedent during her
lifetime and allowed the cotrustees to pay to decedent “such
amounts of trust principal as the Trustee deems necessary for
* * * [decedent’s] care and comfortable support in * * * her
accustomed manner of living, but only if the principal of Trust A
may not in the judgment of the Trustee be readily used for these
purposes.” The Trust B agreement stated that upon the death of
decedent, her sons were entitled to the entire income of Trust B
for life, payable monthly, and the remainder of Trust B would be
distributed in equal shares to decedent’s natural grandchildren.
On October 29, 1991, at the age of 85, decedent created the
Concetta H. Rector Revocable Living Trust (1991 revocable trust)
to which she transferred the assets of Trust A. Decedent and
John Rector were appointed cotrustees of the 1991 revocable
trust, and Frederic Rector was named successor cotrustee. The
1991 revocable trust agreement stated that decedent was entitled
to all of the income and principal from the 1991 revocable trust.
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The 1991 revocable trust agreement granted decedent the power to
amend and revoke the 1991 revocable trust by “written notice
delivered by Trustor during the lifetime of the Trustor to the
Trustees. In the event of such revocation, the Trust Estate
[corpus] or revoked portion thereof shall revert to the Trustor
as her separate property, as if this Trust had not been created.”
4. Decedent’s Move to the Golden Empire Convalescent Hospital
In October 1998, at the age of 92, decedent became a full-
time resident of the Golden Empire Convalescent Hospital
(hospital). She lived there until she died approximately 3 years
later. Her medical expenses, including her residence at the
hospital, cost her $24,588 during 1998, $71,798 during 1999,
$78,114 during 2000, and $94,822 during 2001.
5. Plans To Create a Limited Partnership
Among decedent, John Rector, and Frederic Rector, John
Rector was the first to consider forming a limited partnership to
which to transfer decedent’s assets. John Rector learned of the
idea from Ed Anderson (Anderson), an attorney who had created a
trust for John Rector and his wife and had amended decedent’s
1991 revocable trust agreement. Anderson advised John Rector
that such a limited partnership would allow decedent to give
limited partner interests to her sons and grandchildren, protect
her assets from her creditors, and significantly reduce the value
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of her gross estate through discounts for lack of marketability
and lack of control. John Rector discussed Anderson’s advice
with decedent and Frederic Rector, and decedent and her sons
decided to pursue the idea.
On September 3, 1998, John Rector met with Anderson and two
of Anderson’s colleagues to discuss forming a limited partnership
to which to transfer decedent’s assets.3 Afterwards, John Rector
met with decedent and Frederic Rector, and the three of them
discussed using a limited partnership to save Federal estate tax,
to allow decedent to give limited partner interests to her sons,
to diversify her assets, and to protect her assets from the reach
of her creditors. Decedent and her sons decided to form RLP
without any negotiation over the terms of a partnership
agreement. The three of them intended for decedent to contribute
to RLP all assets she held in the 1991 revocable trust, for no
one else to make any other contribution to RLP, for decedent to
give limited partner interests in RLP to each of her sons, and
for decedent to value the gifts at significantly less than the
proportionate value of RLP’s assets.
In order to structure the partnership and draft the
agreement (RLP agreement), John Rector met with the attorneys in
3
The parties stipulated erroneously that the meeting
occurred on Sept. 3, 1999. A stipulated exhibit establishes that
the meeting occurred on Sept. 3, 1998.
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person, Frederic Rector conversed with the attorneys by
telephone, and decedent corresponded with the attorneys. The
attorneys believed that they represented decedent in this
process, but neither of decedent’s sons had separate counsel as
to the formation of RLP or as to the structuring and drafting of
the RLP agreement.
6. Formation of RLP and Gifts of Partnership Interests
The RLP agreement was executed on December 17, 1998.4 Under
the terms of the agreement, decedent was a 2-percent general
partner in RLP and the 1991 revocable trust was a 98-percent
limited partner in RLP. John Rector was listed in the RLP
agreement as a 0-percent general partner, but he was not in fact
a general partner.5
The RLP agreement stated that RLP was formed
to own and manage the Property contributed by the
Partners and to conduct any other lawful business that
a limited partnership may conduct in the State of
California; to provide a centralized management
structure for all of such contributed and acquired
property; and to provide a convenient mechanism for
4
RLP was formed in California and approximately 1 year
later merged into a Nevada partnership with an identical
partnership agreement. The parties make no distinction between
the California and Nevada partnerships, and neither do we.
5
The parties have stipulated that RLP was formed and
operated as a valid, legal entity under State law. Thus, we
assume the validity of a partnership created by a single
individual as the sole general partner and her revocable trust as
the sole limited partner.
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various family members to participate in the ownership
of family assets.
Article 3.7 of the RLP agreement states that RLP’s “net cash
flow” shall be distributed as follows:
All distributions of Partnership net cash flow shall be
distributed to the Partners in proportion to their
Partnership Interests. “Net Cash Flow” means the
Partnership taxable income, increased by (1) Any
depreciation or depletion deductions taken into account
for computing taxable income; and (2) Any non-taxable
income or receipts (other than capital contributions
from the proceeds of any Partners), and reduced by:
(3) Any principal payments on any Partnership debts;
(4) Expenditures to acquire or improve Partnership
assets; and (5) reasonable reserves, as determined by
the General Partners, for future Partnership expenses
and improvements.
Article 4 of the RLP agreement elaborates on the management
and other specific powers held by the general partners. Article
4.1 and 4.2 states:
4.1 Management by General Partners. Subject to any
limitation imposed elsewhere in this Agreement, the
absolute management and control of the business and
affairs of the Partnership shall be vested in the
General Partners. The General Partners shall have the
full, complete and exclusive right, power and authority
to act for and bind the Partnership in all matters with
respect to the business and affairs of the Partnership.
The Limited Partners shall have no right to take part
in the management of the Partnership.
4.2 Specific Powers of the General Partners. The
General Partners shall have, subject to any limitations
imposed elsewhere in this Agreement, power on behalf of
the Partnership to act with regard to any Partnership
asset, real or personal, and to do anything reasonably
connected with that action. Without limiting this
authority, the General Partners shall have the power to
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sell, exchange, convey title to, and grant options for
the sale of all or any portion of Partnership real or
personal property * * * to borrow money and, as
security for the borrowing, to encumber all or any part
of Partnership property; and to modify, consolidate, or
extend any deed of trust or other security device
encumbering Partnership property.
On March 9, 1999, approximately 3 months after RLP’s
formation, RLP was funded by decedent’s transfer from the 1991
revocable trust of $174,259.38 in cash and $8,635,082.77 in
marketable securities. By virtue of this transfer, the 1991
revocable trust was left with no significant asset other than the
98-percent limited partner interest received in exchange for the
transfer of the cash and marketable securities. At the time of
the transfer, the Trust B assets were worth approximately $2.5
million. Decedent’s entitlement to income from Trust B was
$47,439.12 for 1999.
In March 1999, decedent gave each of her sons, through her
revocable trust, an 11.11-percent limited partner interest in
RLP. Approximately 2 years later, on January 2, 2001, decedent
assigned to the 1991 revocable trust her 2-percent general
partner interest in RLP. On January 4, 2002, decedent’s trust
transferred a 2.754-percent limited partner interest in RLP to
each of her sons. When she died, decedent (through the 1991
revocable trust) owned a 70.272-percent limited partner interest
in RLP and a 2-percent general partner interest in RLP.
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7. Operation of RLP
RLP operated without a business plan or an investment
strategy, and it did not trade or acquire investments. RLP also
issued no balance sheets, income statements, or other financial
statements. RLP’s partners did not hold formal meetings.
RLP functioned to own investment accounts, to make
distributions to partners, and to pay decedent’s personal
expenses (directly during 1999 and indirectly in later years).
RLP maintained monthly statements of investment account activity,
including distributions, and a handwritten check register for
payments. Statements of activity and capital accounts were not
regularly maintained.
8. Summary of RLP Distributions
From its formation through December 11, 2001, RLP made
distributions to its partners. During each of 1999, 2000, and
2001, RLP’s total distributions to its partners exceeded RLP’s
annual net income by $491,480. Of the total distributions, 86 to
90 percent were made to decedent during 1999 and 2000. RLP’s
distributions to each partner represented the following
percentages of RLP’s net income for each year:
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Percentage of RLP’s Net
Year Partner Income/Distribution
1999 Decedent 122.87
John Rector 10.08
Frederic Rector 10.08
2000 Decedent 251.92
John Rector 11.99
Frederic Rector 11.99
2001 Decedent 57.86
John Rector 43.14
Frederic Rector 43.14
9. Payment of Decedent’s Living Expenses and Tax Liabilities
Before forming RLP, decedent received income from Trust B
and from the 1991 revocable trust. Afterwards, decedent
continued to receive the same monthly income from Trust B. The
income from Trust B was decedent’s only significant income
besides the distributions that she received from RLP. For 1998,
1999, 2000, and 2001, decedent received income from Trust B of
$44,481.34, $47,439.12, $43,001.70, and $42,632.78, respectively.
Decedent’s expenses for these years were at least $122,587,
$180,930, $117,754, and $134,961, respectively. The expenses
were attributable to the following:6
6
Decedent also made gifts and charitable contributions not
listed here.
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Expense 1998 1999 2000 2001
Medical/hospital
residence $24,588 $71,798 $78,114 $94,822
Federal income tax 45,174 48,221 3,650 3,239
State/local income tax 16,835 24,911 -0- -0-
Other living expenses 36,000 36,000 36,000 36,000
Total 122,597 180,930 117,754 134,961
In 1999, 29 checks were written on RLP’s checking account to
pay $77,115.03 of decedent’s expenses. Decedent wrote 21 of
these checks, and John Rector wrote the rest. The 21 checks
written by decedent paid the following expenses of decedent:
Date Check
Cleared Payee Amount
4/14/99 Taylor Marketing SVC wheelchair $108.00
4/16/99 IRS 4,311.00
4/16/99 CPA Tax Prep 280.00
4/19/99 California Franchise Tax Board (FTB) 3,902.00
4/19/99 FTB 11,859.00
4/26/99 Taylor Marketing SVC wheelchair 600.00
4/29/99 IRS 7,975.00
4/30/99 Jo Barrett caregiver 50.00
5/5/99 Cash 300.00
5/10/99 Spring Hill Pharmacy--Rx 288.10
5/14/99 Jo Barrett caregiver 50.00
5/19/99 Trinity Episcopal Church 45.00
5/28/99 FG Rector gift, b’day 500.00
6/7/99 Spring Hill Pharmacy--Rx 288.10
6/8/99 Jo Barrett caregiver 60.00
6/10/99 Optical shop--glasses 85.00
6/11/99 FTB 4,311.00
6/15/99 IRS 11,859.00
6/17/99 Unknown 1,500.00
7/12/99 Jo Barrett caregiver 60.00
7/14/99 Spring Hill Pharmacy--Rx 111.56
48,542.76
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The eight checks written by John Rector paid the following
expenses of decedent:
Date Check
Cleared Payee Amount
3/10/99 Hospital $5,301.00
3/30/99 HCFA Health Insurance 763.60
4/8/99 Pharmacy 406.57
4/8/99 Anderson Zeigler Disharoon
Gallagher & Gray
(attorney’s fees) 862.50
4/8/99 Convalescent Hospital 5,130.00
5/4/99 Convalescent Hospital 10,000.00
5/7/99 Convalescent Hospital 5,345.00
5/10/99 HCFA Health Insurance 763.60
28,572.27
In April 2000, RLP transferred $348,100 to decedent’s 1991
revocable trust. The 1991 revocable trust then issued a check in
the same amount, payable to the Internal Revenue Service, for
decedent’s 1999 Federal gift tax liability. In October 2001, RLP
opened a premier variable credit line account and borrowed
$1,303,700 on the credit line. On October 21, 2002, RLP
transferred $1 million to the credit line and wrote on the credit
line a check for $2,038,098 to pay towards the estate’s Federal
estate tax liability. On October 25, 2002, RLP wrote a check for
$262,654 on the credit line to pay the estate’s reported
California estate tax liability. On May 20, 2005, a check for
$384,535 was written on the credit line to satisfy certain
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adjustments to tax resulting from omissions on the estate’s
Federal estate tax return.
10. 1991 and 1999 Cash Gifts
In 1991, decedent’s attorney recommended that decedent make
gifts to John Rector and Frederic Rector during the year in the
total amount of $595,000. Decedent followed this recommendation,
and she informed John Rector that she had made those gifts. On
January 6, 1999, decedent made separate cash gifts of $35,000 to
John Rector and Frederic Rector.
11. Federal Gift Tax Returns
Decedent filed a 1991 Federal gift tax return on October 30,
1992, reporting $595,000 in gifts to John Rector and Frederic
Rector. The return was prepared by an accountant in Nevada
County, California.
Decedent filed a 1999 Federal gift tax return on April 15,
2000, reporting gifts of 11.11-percent limited partner interests
to each of her sons. This return did not report decedent’s
$35,000 cash gifts to her sons.
12. Value of RLP Assets
The estate elected to value decedent’s gross estate as of
the alternate valuation date. On that date, the value of the
assets owned by RLP was $8,126,579.
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13. Federal Estate Tax Return
The estate timely filed a Federal estate tax return on
October 16, 2002. The return failed to report the 1991 and 1999
gifts of $595,000 and $70,000, respectively. The return was
prepared by Anderson and signed by John Rector as coexecutor of
decedent’s estate. The Federal estate tax return reported that
decedent’s gross estate on the applicable valuation date
consisted of a single asset; namely, her interest in the 1991
revocable trust. The return elected the alternate valuation date
of July 11, 2002, as the applicable valuation date. The return
reported that the fair market value of the 1991 revocable trust
as of the applicable valuation date was $4,757,325, calculated as
follows:
Net asset value (NAV) of RLP $8,126,579
Decedent’s interest in RLP 72.272%
Decedent’s proportionate share of NAV 5,873,241
Less 19 percent for lack of control
and lack of marketability 1,115,916
Discounted value of decedent’s interest 4,757,325
OPINION
1. Preface
The value of an interest in property is included in a
decedent’s gross estate if: (1) The decedent made an inter vivos
transfer of the property; (2) the transfer was for less than
adequate and full consideration; and (3) the decedent retained
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the possession or enjoyment of, or the right to the income from,
the transferred property. See sec. 2036(a); see also Estate of
Bigelow v. Commissioner, 503 F.3d 955 (9th Cir. 2007), affg. T.C.
Memo. 2005-65. A decedent’s gross estate does not include the
value of property transferred pursuant to a bona fide sale for
adequate and full consideration. See sec. 2036(a); see also
Estate of Bigelow v. Commissioner, supra at 963.
The estate contends that the values of the assets decedent
transferred to RLP are not included in her gross estate under
section 2036(a)(1) because she relinquished enjoyment of, and the
right to the income from, the transferred assets, and
alternatively, she transferred the assets to RLP in a bona fide
sale for adequate and full consideration.7 For the reasons
7
The estate further argues that sec. 2036(a), to the extent
it applies to this case, applies only to decedent’s transfer of
the limited partner interests to her sons and not to her transfer
of the assets to RLP. To this end, the estate asserts, decedent
received 100 percent of the interests in RLP in exchange for the
assets, which means that the value of decedent’s gross estate was
not depleted by that transfer but was depleted when decedent gave
away the limited partner interests. See Estate of Magnin v.
Commissioner, 184 F.3d 1074, 1079 (9th Cir. 1999) (stating that
the “purpose underlying the section [2036(a)] is to prevent the
depletion of the decedent’s gross estate”), revg. on other
grounds T.C. Memo. 1996-25. As detailed herein, we find on the
basis of the credible evidence at hand that decedent’s transfer
of her assets to RLP and her ensuing gifts of the limited partner
interests to her sons were part of a single plan to minimize
decedent’s Federal estate tax, lacked a significant nontax
business purpose, and accomplished no genuine pooling of assets.
On the basis of those findings, we reject this argument.
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stated below, we reject both arguments. The record here, as did
the record in Estate of Bigelow v. Commissioner, supra, supports
the finding, which we make, that RLP was formed to facilitate the
transfer of decedent’s property to decedent’s sons and
grandchildren primarily as a testamentary substitute, with the
aim of lowering the value of decedent’s gross estate by applying
discounts for lack of control and lack of marketability.
2. Retained Interests
Under section 2036(a)(1), decedent’s gross estate includes
the fair market value of transferred assets to the extent that
she retained possession or enjoyment of, or the right to income
from, the assets for her life or for any other period that does
not end before her death. In order not to have a retained
interest described in section 2036(a)(1), decedent must have
“absolutely, unequivocally, irrevocably, and without possible
reservations,” parted with all of her title, possession, and
enjoyment of the transferred assets. See Commissioner v. Estate
of Church, 335 U.S. 632, 645 (1949). Decedent will have retained
such an interest if there was an express or implied agreement
among the parties to the transfer at the time of transfer that
the transferor retain the possession or enjoyment of, or the
right to the income from, the transferred property. See Estate
of Bigelow v. Commissioner, supra; Estate of Thompson v.
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Commissioner, 382 F.3d 367, 375 (3d Cir. 2004), affg. T.C. Memo.
2002-246; Estate of Maxwell v. Commissioner, 3 F.3d 591, 594 (2d
Cir. 1993), affg. 98 T.C. 594 (1992); Estate of Reichardt v.
Commissioner, 114 T.C. 144, 151-152 (2000). Whether there was
such an understanding or agreement is determined from all of the
facts and circumstances surrounding both the transfer itself and
the assets’ subsequent use. See Estate of Abraham v.
Commissioner, T.C. Memo. 2004-39, affd. 408 F.3d 26 (1st Cir.
2005). In the context of this case, the term “enjoyment”
includes present economic benefits. See Guynn v. United States,
437 F.2d 1148, 1150 (4th Cir. 1971); Estate of Reichardt v.
Commissioner, supra at 151.
The estate contends that there was neither an express nor an
implied agreement for decedent to retain possession, enjoyment,
or the right to income from the assets that she transferred to
RLP. We disagree. We find on the basis of the credible evidence
at hand that decedent and her sons had an implied understanding
that decedent would retain enjoyment and the right to income from
the transferred assets.8
The RLP agreement reflects an understanding among decedent
and her sons that decedent would retain her interest in the
8
Given this finding, we need not and do not decide whether
they also had an express agreement that decedent would retain
enjoyment and the right to income from the transferred assets.
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transferred assets by virtue of her ability to control those
assets, including the management and disposition thereof.
Initially, as the direct general partner of RLP, decedent was
given the right by the RLP partnership agreement to cause a
distribution of RLP’s net cashflow to RLP’s partners in
proportion to their partnership interests, and she was given the
power “to do anything reasonably connected” with RLP’s assets.
Later, as an indirect (through the 1991 revocable trust) general
partner of RLP, decedent continued to retain that right and power
directly in that she was a cotrustee of the 1991 revocable trust
and, most importantly, she had the absolute power to revoke the
trust as if it had never been created in the first place. Thus,
at all relevant times, decedent held both a majority interest in
RLP and the powers incident to serving as RLP’s general partner.
We also find as a fact that decedent and her sons agreed
impliedly that the transferred assets and the income earned
therefrom would continue to be used for decedent’s pecuniary
benefit. The transfer of practically all of decedent’s wealth to
RLP left decedent with insufficient liquid assets with which to
pay her living expenses. The estate asserts that decedent’s
assets were sufficient because Trust B had a corpus of $2.5
million at the time of the transfer and decedent’s sons, as
cotrustees, could distribute Trust B’s corpus to pay decedent’s
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expenses. The estate’s argument is unavailing. When RLP was
formed, decedent and her sons knew that decedent’s annual income
from Trust B, which for 1998 was $44,481, would be insufficient
to cover decedent’s annual expenses of approximately three times
as much. Decedent had just become a full-time resident at the
Hospital, where her residence resulted in medical costs totaling
$71,788 for 1999, $78,114 for 2000, and $94,822 for 2001.
Decedent and John Rector also directly drew over $77,000 in funds
from RLP during 1999 to pay decedent’s personal expenses. The
estate attempts to downplay the significance of the direct use of
RLP funds to pay decedent’s personal expenses by attributing that
use to “errors”. In the light of John Rector’s extensive
financial expertise and his testimony that it never occurred to
him that RLP should be reimbursed for such “errors” after they
were discovered, we find that this argument lacks credibility.
We also note that the Trust B agreement allowed the
cotrustees to pay to decedent amounts of trust principal
necessary for her “care and comfortable support in * * * her
accustomed manner of living”. The implied understanding among
decedent and her sons was that the assets of RLP would be readily
used to meet decedent’s expenses and that the corpus of Trust B
would not be invaded. We conclude that the principal of Trust B
was not available in any significant sense to decedent to pay her
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living expenses. In fact, decedent never even asked her sons to
distribute Trust B principal to her when her monthly income was
insufficient to cover her expenses; rather, decedent relied
heavily on the assets she had transferred to RLP and the income
earned therefrom.9
In sum, we conclude that decedent impliedly retained
enjoyment of and the right to income from the assets that she
transferred to RLP. Decedent derived economic benefit from using
RLP’s assets to pay her living expenses, to meet her tax
obligations, and to make gifts to her family members. Such use
of RLP’s assets shows an agreement among decedent and her sons
that decedent would retain the enjoyment of and the right to
income from the transferred assets by withdrawing those assets
and/or income from RLP at will.
3. Bona Fide Sale for Adequate and Full Consideration
Under the exception to section 2036(a) contained in that
section, a decedent’s gross estate does not include the value of
property transferred in “a bona fide sale for an adequate and
9
RLP transactions in 2002 and 2005 also illustrate the
implied agreement among decedent and her sons that the
transferred assets would continue to be used for the liabilities
of decedent, even after her death. In those years, an RLP credit
line was used to pay decedent’s Federal and State tax liabilities
of $2,038,098 and $262,654, respectively. A check also was
written on the RLP credit line for $384,535 to pay some of
decedent’s Federal estate tax.
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full consideration in money or money’s worth”. The exception
aims to exclude from the reach of Federal estate and gift taxes
transfers in which a decedent received consideration sufficient
to protect against depletion of the estate’s assets. See Estate
of Magnin v. Commissioner, 184 F.3d 1074, 1079 (9th Cir. 1999),
revg. on other grounds T.C. Memo. 1996-25. The estate argues
that the transfer of decedent’s assets to RLP in exchange for the
entire interest in RLP was a “bona fide sale” for which decedent
received adequate and full consideration and, hence, that section
2036(a) does not apply here. We disagree. The transfer of
decedent’s assets to RLP in exchange for the entire interest in
RLP was not “a bona fide sale for an adequate and full
consideration” within the meaning of section 2036(a).
First, the formation of RLP entailed no change in the
underlying pool of assets or the likelihood of profit. Without
such a change or a potential for profit, decedent’s receipt of
the partnership interests does not constitute the receipt of full
and adequate consideration. See Estate of Bongard v.
Commissioner, 124 T.C. 95, 128-129 (2005); see also Estate of
Bigelow v. Commissioner, 503 F.3d 955 (9th Cir. 2007).
Second, to constitute a bona fide sale for adequate and full
consideration, decedent’s transfer of the assets to RLP must have
been made in good faith. See sec. 20.2043-1(a), Estate Tax Regs.
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For this purpose, good faith requires that the transfer be made
for a legitimate and significant nontax business purpose. See
Estate of Bongard v. Commissioner, supra at 118; Estate of Rosen
v. Commissioner, T.C. Memo. 2006-115. A transaction between
family members is subject to heightened scrutiny to ensure that
the transaction is not a disguised gift. See Estate of Bigelow
v. Commissioner, supra at 969; Harwood v. Commissioner, 82 T.C.
239, 258 (1984), affd. without published opinion 786 F.2d 1174
(9th Cir. 1986).
With respect to good faith in transactions between family
members, this Court has considered whether “the terms of the
transaction differed from those of two unrelated parties
negotiating at arm’s length.” Estate of Bongard v. Commissioner,
supra at 123. The parties’ actions during the formation of RLP
contrast starkly with those that would be anticipated from
unrelated parties forming a limited partnership. Decedent and
her sons did not negotiate the terms of the RLP agreement, and
they did not retain independent counsel. Decedent (through her
revocable trust) made all contributions to RLP, and her
contributions constituted the vast bulk of her wealth. RLP was
formed with decedent and her revocable trust as the only
partners. RLP was not actually funded until nearly 3 months
after it was formed. We also note that the RLP partnership
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agreement contemplated that more than one partner would
contribute property to RLP but that decedent and her sons never
intended that anyone other than her (or her, through her
revocable trust) would actually contribute property to RLP.
As to the need for a significant nontax business purpose, we
inquire whether the transfer of assets to RLP was reasonably
likely to serve such a purpose at its inception. See Strangi v.
Commissioner, 417 F.3d 468, 480 (5th Cir. 2005), affg. T.C. Memo.
2003-145. The estate asserts that the motivation behind the
formation of RLP was the desire to benefit from estate tax
savings, the ability to give away partnership interests, the need
to protect decedent’s assets from her creditors, and the desire
to diversify decedent’s assets. We disagree with the estate that
decedent had the requisite purpose when she transferred her
assets to RLP. The estate’s stated goal of gift-giving is a
testamentary purpose and is not a significant nontax business
purpose. See Estate of Bigelow v. Commissioner, supra; see also
Estate of Schauerhamer v. Commissioner, T.C. Memo. 1997-242. Nor
is the estate’s stated goal of efficiently managing assets such a
purpose, given the lack of evidence that RLP required any special
kind of active management. See Estate of Bigelow v.
Commissioner, supra. The protection of assets against creditors
also is not such a purpose in that the record does not establish
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any legitimate concern about the liabilities of decedent, nor did
decedent’s transfer of her assets to RLP actually protect the
assets from her creditors in that she or her trust was at all
times an RLP general partner. See id. The estate’s stated claim
to a diversification of assets also is not such a purpose in that
RLP’s ownership and management of the transferred assets was
essentially identical to the 1991 revocable trust’s pretransfer
ownership and management of those assets. We also note that RLP
had no investment strategy or business plan of providing added
diversification of investments; rather, RLP held the securities
transferred by decedent without any substantial change in
investment strategy and did not engage in business transactions
with anyone outside of the family.10 See Estate of Thompson v.
Commissioner, 382 F.3d at 378 (partnership lacked substantial
nontax purpose under similar facts). Given these findings and
conclusions, and our additional findings as to decedent’s age and
health at the time of RLP’s formation, as well as the fact that
only decedent’s cash and marketable securities were contributed
to RLP, we conclude that the formation of RLP was more consistent
10
While the estate discerns a business purpose from the
banking and securities investments of decedent’s predeceased
spouse and his parents, we find that family history to have no
bearing on this case.
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with an estate plan than an investment in a legitimate business.
Id. at 377; see also Estate of Rosen v. Commissioner, supra.
4. Accuracy-Related Penalty Under Section 6662
Section 6662(a) and (b)(1) imposes an accuracy-related
penalty equal to 20 percent of the portion of an underpayment
which is attributable to negligence or disregard of rules or
regulations. The term “negligence” includes any failure to make
a reasonable attempt to comply with the internal revenue laws or
to exercise ordinary and reasonable care in the preparation of a
tax return. See sec. 1.6662-3(b)(1), Income Tax Regs. The term
“disregard” includes any careless, reckless, or intentional
disregard of rules or regulations. See sec. 6662(c). Section
6664(c) provides that no penalty shall be imposed under section
6662 with respect to any portion of an underpayment if the
taxpayer can show that the taxpayer acted with reasonable cause
and in good faith.
Respondent determined that the estate was negligent in
failing to report the $595,000 of prior gifts as adjusted taxable
gifts on the estate’s Federal estate tax return. We agree.11
11
Neither party mentions the applicability of sec. 7491(c).
That section provides that the Commissioner has the burden of
production “in any court proceeding with respect to the liability
of any individual for any penalty, addition to tax, or additional
amount imposed by this title.” We need not decide whether sec.
7491(c) applies to estates because the record is sufficient to
(continued...)
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John Rector, who signed the return as coexecutor of the estate,
had extensive expertise in financial matters. He knew, or at
least should have known, about the omission in his capacity as
cotrustee of decedent’s 1991 revocable trust, as coexecutor of
decedent’s estate, and most significantly as the donee of
one-half of the $595,000. The estate makes no showing of
reasonable cause or good faith with respect to the omission.
_______________________________________________
We have considered all arguments by petitioner for holdings
contrary to those reached herein and find those agreements not
discussed herein to be without merit.
Decision will be entered
under Rule 155.
11
(...continued)
meet any burden of production respondent may have with respect to
his determination of negligence.