tax court family limited partnership

Tax Court Penalties for Family Limited Partnership

Deathbed Planning and Tax Avoidance Sink Family Limited Partnership in Tax Court

Estate planning attorneys often tell clients, “It’s never too early to start planning.” Time offers more options than any other factor, and last-minute planning can lead to costly mistakes. Let’s see why one executor ended up in tax court after claiming a valuation discount on a family limited partnership.

TABLE OF CONTENTS

How Bad Faith and Bad Facts Landed a Family Limited Partnership in Tax Court

The case in question involves Texas oil tycoon Anne Milner Fields and her great-nephew Bryan Milner. In 2010, Ms. Fields created a last will and testament, durable power of attorney, and medical power of attorney, appointing Mr. Milner as her agent and personal representative on each of these documents. 

In early 2011, Ms. Fields was diagnosed with Alzheimer’s-related dementia. She fell and broke her hip a few months later and was placed in a long-term care facility not long after. As her power of attorney, Mr. Milner had the authority to control Ms. Fields’ finances, including creating financial structures to hold and distribute her property. 

In May 2016, Mr. Milner and his counsel formed a family limited partnership (FLP), with Ms. Fields as the sole limited partner and an LLC, AM Fields Management, as the sole member and manager. Ms. Fields contributed most of the assets and received a 99.9941% limited partnership interest; through the LLC, Mr. Milner contributed $1,000 to the FLP for a 0.0059% general partnership interest. 

When Ms. Fields passed away in June 2016, Mr. Milner used an accounting firm to prepare her estate tax return. AM Fields had approximately $17 million in contributed assets. However, due to a family limited partnership valuation discount of 15% for lack of control and 25% for lack of marketability, Ms. Fields’ partnership interest was valued at $10,877,000.

To put it mildly, the tax court, to put it mildly, disagreed.

The court determined that the transfers made to the FLP in the months preceding her death were not bona fide transactions, as Ms. Fields retained rights and interests over the transferred assets until her death. Under Section 2036(a), the decedent’s gross estate should include the fair market value of those assets at the time of her death.

To make matters worse, the court also found that there was no reasonable cause for the estate’s underpayment, as there was no proof that the discount was taken in good faith on the tax return. The estate was assigned an additional penalty for inaccuracy and disregard of regulations.

So… there’s a lot that went wrong here, but some of the major factors include:

Problem 1: Scrambling to Form a Plan

Asset protection planning must be strategic, not immediate.

Mr. Milner had control over Ms. Fields’ finances since 2011, but it would be five more years before he started transferring wealth into asset protection structures. Transferring $10M to the FLP a month before Ms. Fields’ passing looks a lot like making deathbed gifts for estate tax purposes—even if unintentional.

Deathbed planning has plenty of potential for mistakes. Wills or trusts drafted in haste may be improperly executed, causing disputes after the person passes away. These conflicts can cause prolonged legal battles, emotional strain, and diminished inheritances. If there are multiple heirs, it’s likely that an excluded heir brings a claim of undue influence over the decedent by the person who had the power of attorney.

Of course, lack of time means a lack of consideration for tax implications. Rushed estate planning may overlook opportunities to reduce estate taxes, such as by setting up trusts or making gifts before death. Without adequate planning, the estate may be subjected to high tax burdens that could have been avoided with more foresight.

Problem 2: A One-Man Show

A single person controlling all sides of the transaction is problematic.

It’s hard to find a role Mr. Milner didn’t play: he was the sole manager and member of the LLC, the general partner of the FLP, the executor of the estate, and the POA for both finances and healthcare. Oh, and he used his power of attorney to execute all relevant documents for the creation of the FLP on Ms. Fields’ behalf.

While it might seem convenient for one person to hold all the roles of power, doing so can create significant conflicts of interest and practical challenges. Each of these roles has distinct duties and responsibilities, and combining them can create conflict between personal interests and fiduciary duties.

Having a single person in control also leads to a lack of checks and balances. If the person handles all aspects of the estate, trust, and medical or financial decisions, there is less oversight to ensure their actions are fair and in the best interests of all parties. Without an independent person or entity overseeing one of these roles, there is greater potential for misuse or negligence.

Problem 3: An Unstable Foundation

Avoiding taxes is not a legitimate policy basis for creating structures.

Yes, we’ve said it before. You can’t create a [insert planning instrument here] for the sole purpose of avoiding tax. If you’re avoiding estate tax with a family limited partnership, the IRS will want you to back up your legitimate reasons for creating the partnership.  

In the above case, the estate attempted to argue that the partnership was a way to protect Ms. Fields from financial elder abuse. The court allowed that Ms. Fields had been the victim of elder abuse scams before, but these had happened years before the formation and funding of the FLP.

When the estate further claimed that AM Fields was necessary to manage pooled assets, the court pointed out that Mr. Milner had only contributed $1,000, making the FLP less of a joint venture than “a vehicle to reduce estate tax.”

Don’t Be Misled by Bad Advice

A good business lawyer will let you know when a deal is too good to be true. Fortunately, our team has years of experience drafting documents and road-testing them to make sure your plan works as intended. Email us at [email protected] today or schedule a 15-minute call to see how we can help.