DISCUSSION:

Mr. Black’s Estate:

IRC § 2036(a) requires estates to include assets from the value of the gross estates except in certain instances (“except in the case of a bona fide sale for an adequate and full consideration in money or money’s worth”). In particular, § 2036(a)(1) includes in gross estates “the possession or enjoyment of, or the right to the income from, the property” which the decedent (in general) enjoyed even if a transfer of the property had taken place.

The estate of Mr. Black argued that the formation of BILP was for legitimate non-tax reasons, including, but not limited to:

• Long-term management and protection of the family’s Erie stock holdings,
  
• Pooling the family’s Erie stock holdings to allow the stock to vote as one block, thereby capitalizing on the block’s swing vote characteristics, and
  
• To protect the Erie stock from creditors and divorce.

Further, the estate cited accomplishment of the goals of the Partnership in its argument. Additionally, the estate maintained the transfer was for full and adequate consideration.

The IRS rejected the estate’s arguments and asserted that the formation of BILP was not necessary to further the family’s goals. The IRS did not believe full and adequate consideration was paid and that Mr. Black maintained an interest in the transferred Erie stock, thereby allowing to be included in his gross estate.

Mrs. Black’s Estate:

Although disadvantageous to the estate in terms of tax payments, Mrs. Black’s son selected her date of death as the date of funding for the marital trust. In so arguing, the estate believed that was the earliest possible date at which the value of Mr. Black’s estate value could be calculated and the amount passed to Mrs. Black could be determined.

The IRS held no position on the estate’s date determination, stating that § 20.2044-1(e) provides no clarity to the funding date of a QTIP trust when the surviving spouse dies before the trust is funded.

The estate argued that the interest on the $71 million loan was tax deductible. The estate believed Son exercised reasonable business judgment in executing the loan rather than causing a distribution or forcing redemption from BILP. Additionally, the loan was bona fide because there was

• A note,
  
• Security,
  
• Interest charges,
  
• Repayment schedule,
  
• Actual repayment of the loan, and
  
• Relationship between borrower and lender created a reasonable expectation or enforceable obligation to repay the note.

Additionally, the estate claimed deductions of almost $1 million to BILP to reimburse the Partnership for monies it paid to Erie for the secondary offering.  Estate also claimed $1.155 million in legal fees and $1.155 million in executor fees.

The IRS rejected the estate’s arguments. The IRS’ position on loan deductibility was:

• Repayment that the loan was created for the tax deductibility of the interest,
  
• Son was in a position to distribute from BILP enough Erie stock to cover the liability,
  
• Son was in a position to redeem at least a portion of Mrs. Black’s BILP interest,
  
• The only way for BILP to repay the loan was to redeem Erie stock, which, made the loan pointless.

Further, the IRS sought to deny the full amount of reimbursement to BILP and any portion over $500,000 in legal and executor fees.

CONCLUSION:

Mr. Black’s Estate:

The court ruled that the formation of BILP was for legitimate non-tax reasons. The Tax Court found Mr. Black had legitimate concerns about:

• his grandsons selling their Erie stock upon termination of their trusts and the resulting dilution of Erie stock, and
• his Son’s marriage and dilution of Erie stock should the stock become marital property.

As a result of the preceding, the Court found that Mr. Black’s transfer of Erie stock to the Partnership was a bona fide sale. Because the IRS acknowledged that the partners of BILP received partnership interests in proportion to the fair market value of the assets contributed, the full and adequate consideration prong of Estate Tax Regulation § 20.2043-1(a) definition of bona fide sale. Accordingly, only the fair market value of Mr. Black’s limited partnership interests in BILP (not the value of the Erie stock the Decedent transferred to the Partnership) is includable in his estate under 2036(a).

Significantly, the Tax Court found in this case as in Estate of Schutt v. Commissioner “that a family limited partnership that does not conduct an active trade or business may nonetheless be formed for a legitimate and significant nontax reason.”

Mrs. Black’s Estate:

The court found that the value of the marital trust likely could not have been knowable as of the date of Mr. Black’s death in December 2001, as the trust would be funded with Partnership interests. As evidence, the Court cited the date of valuation of the Decedent’s interest in BILP (September 2002), more than 3 months after Mrs. Black’s death in May 2002. Accordingly, her date of death was the latest reasonable date on which to consider the trust funded. 

Turning to the loan to pay Mrs. Black’s estate taxes and administration fees, the Court sided with IRS in ruling the loan interest was not a deductible expense. The ruling was determined primarily because the Partnership lacked sufficient income and distributions to partners to repay the loan without the sale of Erie stock at the loan’s maturity date. If the sale of Erie stock was necessary and enforceable at the maturity date, it was necessary and enforceable at the date of death, making the loan unnecessary. 

Finally, the court determined that only 49% of the secondary offering by BILP was used on behalf of Mrs. Black’s estate. Accordingly, only 49% of the fee could be deducted. The court also held that because the executor for both Mr. and Mrs. Black was working on both estates simultaneously and because the estates were so intertwined, deductibility of executor fees should be split between the estates. Similarly, the court permitted deductibility of only one-half of the legal fees as only one-half of the work performed benefitted Mrs. Black’s estate. 

In contrast to Estate of Malkin v. Commissioner, Estate of Black v. Commissioner shows that proper financial and legal estate tax planning can be invaluable to the tax payer, particularly in Mr. Black’s case. Because of proper planning and documentation, the court found that although BILP was a passive entity it was still created for legitimate and significant nontax reasons. The case is a clear victory for use of the FLP in estate tax planning.