Welcome to Taxview with Chris Moss CPA Tax Attorney
If you have been following TaxView with Chris Moss CPA Tax Attorney regarding Irrevocable Spousal Lifetime Access Trusts and Domestic Asset Protection Trusts (SLATs and DAPTs) we have recommended best practice in 2019 is to have your Irrevocable SLAT/DAPT own your Family or Holding LLC partnership with your spouse, children and grandchildren as beneficiaries, and to transfer as much of your assets to your family Holding LLC as you can prior to the 2020 elections. However, there are IRS traps waiting to be sprung, as the Government waits, patiently I might add, until you die, disallowing your 2019 gift tax returns and bringing back all those assets ($22.8M married in 2019) back into your estate to be taxed at whatever rate Congress has enacted at the time of your death. The trap? The Business Purpose Doctrine of Court made case law and the IRS Code Section 2036(a): Your estate plan must have a legitimate non-tax business purpose. Seems simple, but perhaps not so simple. How to avoid this trap? Stay with us here on TaxView, with Chris Moss CPA Tax attorney to find out how to easily maneuver past this trap so your SLAT/DAPT and family Holding LLC will be created on a solid structural foundation to withstand the IRS storms ahead when your estate gets audited years after your passing.
We are going to start with what seems to be a very simple concept the “Business Purpose Doctrine”. Courts have held that any structure set up to primarily avoid paying tax will not withstand an IRS audit unless the structure has a legitimate “Business Purpose”. “The objective evidence must indicate that the non-tax reason was a significant factor that motivated the Estate Plan Family Holding LLC creation. A significant purpose must be an actual motivation, not a theoretical justification. Estate of Bongard v Commissioner, 124 T.C. 95, 118 (2005). However, as simple as it seems the Business Purpose Doctrine has been the downfall of many estate plans. This is especially true for the Family Holding LLC set by Edward Beyer as his estate discovered after his death in US Tax Court Case Beyer v IRS T.C. Memo 2016-183. The facts are very complex, but in essence Trusts were set up and eventually owned Holding Company EGBLP. The IRS auditors claimed that the value of the assets Beyer transferred to EGBLP through the Trusts should be includible in the value of his gross estate under Section 2036(a).
Judge Chiechi of the US Tax Court asks on page 114 of this long Opinion “Was there a transfer of property by Beyer, for full consideration, and if not did Beyer retain possession or enjoyment of the right to income within the meaning of Section 2036(a)(1) or did he retain the power of appointment, the right to designate the person would would enjoy the property transferred. The Court finds that a transfer was made but in order to avoid Section 2036(a) that had to be a bona fide sale. In connection with a family Holding company the Court points out that “where the record establishes the existence of a “legitimate” and significant non tax reason for creating the Family LLC and the transferors received partnership interests proportionate to the value of the property transferred then the “bona fine sale” exception under 2036(a) is satisfied. Citing Estate of Bongard V IRS 124 T.C. 95 at page 118 (2005).
Unfortunately for Beyer his only non-tax reasons for setting up the EGBLP was to keep some stock holdings in a block, to give his brother experience in managing Beyer’s assets, and to ensure continuity of management of his assets. The Court found that none of these were legitimate non-tax reasons based on the facts that Beyer presented. The Court eventually found for the IRS claiming that there was no legitimate business purpose in Beyer created his Family Holding LLC and that therefore Section 2036(a) would claw back the transfers back into the Beyer’s estate. IRS wins Beyer loses.
Lea Hillgren’s estate found out they made the same mistake as Beyer when Hillgren in early 1997 shortly before her death, but after various suicide attempts, her CPA Tax Attorney set up in California her family Holding company, LKHP. But after her final successful suicide death in June of 1997 the IRS audited and clawed back the transfers back into the Hillgren estate claiming LKHP had no legitimate business purpose. Hillgren’s estate appealed to the US Tax Court. The facts in Estate of Hillgren vs IRS T.C. Memo 2004-46. are rather complex. Lea Hillgren set up LKHP her family LLC as a California limited partnership to own various income-producing properties. She did not marry and had no children but had an on again off again relationship with O’Brien. Unfortunately, Hillgren at age of 41 committed suicide and was survived by her parents and brother.
Hillgren’s estate contends that the creation of LKHP was indeed motivated by legitimate business interests. The first business purpose the estate put forth for LKHP was a “premarital asset protection” device, but IRS points out that Hillgren permanently broke up with O’Brien before her initial unsuccessful suicide attempt. The Court notes that it is unclear from the record whether Obrien and Hillgren were intending to get married. The IRS argues further that under California law as a community property state Hillgren still had the right to transfer her interest to a spouse and had the power to approve that transfer in spite of the LKHP operating agreement prohibition over such transfer. Judge Cohen concludes “There is nothing in the language of the LKHP agreement stating the reasoning behind the formation of the partnership….The estate’s claim that the partnership served to protect decedents assets from an impending marriage to O’Brien is unsupported by the record, therefore, the Court concludes that “the value of the properties that were transferred to Family Holding Company LKHP are includable in Hillgren’s estate under Section 2036(a). IRS Wins, Hillgren loses.
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Finally, once again a lack of business purpose proved fatal for Theodore R Thompson when IRS clawed back all his assets from his Family Holding LLC. After losing in US Tax Court Estate of Thompson, Betsy Turner Executrix vs IRS T C Memo 2002-246 the estate appealed to the 3rd Circuit in Turner v IRS over at the 3rd Circuit 382 F.3d 367 (3d Cir. 2004) claiming that the Family Holding company, Thompson Corporation had a legitimate business purpose. Chief Judge Scirica of the 3rd Circuit points out that even if the Thompson’s transfer had a retained lifetime interest it could still avoid the claw back of Section 2036 (a) if the transfer was a “bona fide sale for adequate and full consideration, citing IRS Code 2036(a). Scirica noted that the Tax Court concluded there were no legitimate business concerns citing the US Tax Court case Estate of Thompson, Betsy Turner Executrix vs IRS TC Memo 2002-246. Further citing Strangi v IRS 85 TCM at 1331 (2003) where the Strangi family LLC engaged in no business operations or commercial transactions until Strangi’s death. The Court concluded that the Family LLC fails to qualify as the sort of functioning business enterprise that could potentially inject intangibles that would lift the situation beyond mere recycling. Strangi 85 TCM at 1344. Judge Scirica argues that “for essential the same reasons, we conclude there was no transfer for consideration within the meaning of Section 2036(a). The record demonstrates that the Family LLC was not a valid functioning business enterprise and did not rise to the level of legitimate business operations.
As the 3rd Circuit concludes by citing the US Supreme Court a “good faith” transfer to a family limited partnership must provide the transferor some potential for benefit other than the potential estate tax advantages that might result from holding assets in the partnership form. Even when all the “i’s are dotted and t’s are crossed,” a transaction motivated solely by tax planning and with “no business or corporate purpose . . . is nothing more than a contrivance.” Gregory v. Helvering, 293 U.S. 465, 469, 55 S.Ct. 266, 79 L.Ed. 596 (1935). As discussed in the context of “adequate and full consideration,” objective indicia that the partnership operates a legitimate business may provide a sufficient factual basis for finding a good faith transfer. But if there is no discernable purpose or benefit for the transfer other than estate tax savings, the sale is not “bona fide” within the meaning of § 2036.
Chief Judge Scirica concludes for the 3rd Circuit that after a thorough review of the record, we agree with the Tax Court that decedent’s inter vivos transfers do not qualify for the § 2036(a) exception because Turner’s Family LLC did conduct any legitimate business operations, nor provided decedent with any potential non-tax benefit from the transfers. IRS Wins Thompson Estate Loses.
Now that we all understand the Business Purpose Doctrine Trap, how does the Business Purpose Doctrine apply to you and how you can avoid it? While the Business Purpose Doctrine Trap seems easy enough to navigate around, quite a few estate plans put forth by very highly paid Attorneys and CPAs have been tripped up by this trap. Don’t let this happen to you. Make sure your CPA Tax Attorney creates your SLAT/DAPT estate plan with a Family Holding LLC that has numerous legitimate non-tax business purposes specifically as they relate to your spouse, children and grandchildren, and make sure you get a written guarantee from your tax professionals, hopefully at no extra charge, that they will defend any IRS Section 2036 (a) Business Purpose Doctrine audit years after the gift tax returns are filed, after your SLATs and DAPTs have been created after your Family Holding LLC has been set up, after all the partnerships and personal tax returns have been filed, and perhaps most likely a few short years after you have passed. Bullet proof your SLAT and DAPT from the IRS Business Purpose Doctrine SLAT/DAPT Family LLC Audit. Your spouse, children and grandchildren will be most thankful that you did. Thank you for joining us on TaxView with Chris Moss CPA Tax Attorney.
See you next time on TaxView with Chris Moss CPA Tax Attorney.
