It is a truth universally acknowledged that a recently widowed woman in possession of a good fortune must be in want of an estate planner. Thelma Hurford had devoted her life to family and friends, leaving the management of finances to her husband Gary. When he died suddenly, she had to learn what they owned and decide what to do with it. While she struggled with this burden, she was herself stricken with cancer and so had to arrange the accelerated planning of her own estate. Two attorneys vied for her attention and she chose Joe B. Garza. She lost her life to cancer. We must now decide how much of her estate will be lost to taxes.
Thelmas husband, Gary, rose through the ranks to become the first president of Hunt Oil Company who was not named Hunt. Eventually, Thelma quit her job as an elementary school teacher to raise their three children, Gary Michael (Michael), David, and Michelle. Michael graduated from medical school and practices as a psychiatrist. Michelle, after obtaining her degree from the University of Texas at Austin, took a job helping with the familys bookkeeping. David struggled with numerous problems throughout his life. David lived near his parents for his whole life and worked on one his fathers ranches.
Gary and Thelma were conservative with their estate planning, eschewing strategies such as irrevocable life insurance trusts, grantor retained annuity trusts, and family limited partnerships in favor of a revocable living trust with standard estate tax planning provisions. At the time of his death, Garys and Thelmas joint estates were in excess of $14 million. Garys Will distributed his share of the joint estate as follows: (1) Garys share of the couples two residences to be distributed outright to Thelma, (2) $650,000 (the amount that could be passed free of estate tax in 1999) to be distributed to the Bypass Trust and (3) the balance of Garys estate to be distributed to a QTIP Trust (a QTIP, or qualified terminal interest property trust is a special trust that benefits the surviving spouse and qualifies for the unlimited marital deduction). Because of the unlimited marital deduction, there was no estate tax due upon Garys death, but Thelmas estate of more than $13 million would be taxable upon her death.
Thelmas estate planning attorney at that time, Santo Bisignano, diligently went about probating Garys estate, valuing the estate assets, preparing an allocation of the assets among the various trusts, and starting the preparation of the Form 706 federal estate tax return. Thelma also sought Bisignanos advice on reducing the estate tax and he suggested she use her $675,000 lifetime gift tax exemption amount to fund gifts of $225,000 to each of her children. The children could then use those funds to fund their contributions to a family limited partnership.
In 2000, Thelma was diagnosed with cancer and she grew impatient with Bisignanos slow and conservative approach and less than engaging personality. Thelma enlisted Michaels assistance in finding a new estate planning attorney. Michael received a referral to Joe Garza, an engaging estate planning attorney who proposed a plan to dramatically reduce the familys estate taxes.
The plan involved the creation of three family limited partnerships (FLPs), one to hold the stocks and other liquid assets, the second to own Garys phantom stock in Hunt Oil, and the third to hold the farm and ranch properties. These partnerships were to be funded not just from the assets of Thelmas estate, but also with the assets of the bypass and QTIP trusts. Thelma would then sell the partnership interests to her children in exchange for a private annuity.
Garza got to work creating the FLPs. The partnership agreements contained numerous typos and errors, including references to a trust that didnt exist and naming the same limited liability company (LLC), HM-1, as general partner for all three FLPs, even though Garza had created three separate LLCs to serve as general partner, one for each FLP. The IRS also raised the issue that Garza created the limited partnership interests before the partnerships were funded. Other issues included: (1) a long delay in funding the partnership, (2) continued use and control of the funds by Thelma (she paid her personal income tax debts from funds that were designated as partnership funds), (3) the capital accounts reflected on the partnership tax returns did not reflect the reality of the transactions, (4) there were problems with the deeds purporting to transfer the ranch and farm properties to the family limited partnerships, (5) Michael, Michelle and David were the intended beneficiaries of Thelmas estate plan (according to testimony at trial), yet David was excluded from the FLP and annuity transactions (presumably because of his financial difficulties), and (6) Michael and Michelle did not have the financial ability to make the required $80,000 per month payments on the private annuity (meaning that the funds used to make the payments were the same funds distributed out to Michael and Michelle).
Strangely, Garza also transferred the residences and funds from the liquidation of a large IRA (which were not intended to be part of the FLPs), to the partnerships. He also transferred the assets of the Bypass Trust (which were already excluded from Thelmas estate) and the QTIP Trust (which limited Thelmas access to income and principal distributions for health, education, maintenance and support) to the FLPs. Garza obtained several quotes from appraisers to value the partnerships, LLCs, and private annuity, but never hired any of the appraisers. Instead, he and the CPA firm he hired to finish Garys estate tax return and prepare Thelmas gift tax returns and estate tax return assigned arbitrary, unsupported discounts to the properties (many of which were valued using the amounts shown on Garys estate tax return and not the value of the assets at the time the transfer occurred).
The tax court held that the assets of the FLPs were included in Thelmas estate for many reasons. First, the reality of the transactions is that Thelma continued to have access and control over the FLP assets even after she had supposedly sold them in exchange for the private annuity, bringing the transferred property back into her estate under Internal Revenue Code 2036. Second, the court found no business purpose for the family limited partnerships other than estate tax savings. The court disregarded the litany of reasons given, such as asset protection, centralized management, and ease of transfer. It found the partnerships gave no greater protection than the trusts that were already in existence, that nothing changed with regard to management of the properties, and that the partnership did not simplify the transfer of the assets. Third, the court held there was no actual sale because the private annuity had no economic reality. The court made this determination because Michael and Michelle did not have the financial resources to make the required annuity payments and the documents did not reflect Thelmas intent to benefit David as well as Michael and Michelle. The court held that Thelma had no power to transfer the assets in the QTIP Trust in the manner in which she did and that those assets would be included in her estate.
Unfortunately, the net result of all the planning in which Thelma engaged, for which she was charged in excess of $300,000 in legal and accounting fees, was that her family ended up paying more in estate taxes than if Thelma has not done additional estate planning after her husband died. By transferring the assets owned by the Bypass Trust to the family limited partnerships, property that was previous exempted under Garys applicable exclusion amount became subject to estate tax upon Thelmas death. The estate was also subject to penalties and interest related to underpayment of taxes.
There are many morals to this story. The first is that estate planning attorneys need to be very careful to cross their ts and dot their is in order to assure that entities are properly formed under the law. Second, after the entity is formed, it must be properly administered proper procedures followed, including establishing separate bank accounts and filing tax returns. Third, it is important to engage qualified professionals to assist with income, gift, and estate tax planning and tax preparation services, as well as to provide supportable valuations for assets. Fourth, estate tax savings cannot be the sole motivation for engaging in many advanced estate planning strategies. In order for the IRS and courts to respect the transaction, there must be other legitimate personal or business reasons for engaging in the transactions. Fifth, and perhaps most importantly, taxpayers need to understand that, with many estate planning strategies, they cannot have their cake and eat it too. In other words, under most circumstances, for a transfer to be respected the taxpayer must give up all beneficial interest in and control over the asset.
Our law firm provides advice on estate tax savings strategies, including irrevocable life insurance trusts, family limited partnerships and limited liability companies, qualified personal residence trusts, grantor retained annuity trusts, various charitable planning strategies, and other techniques. Our lawyers not only provide assistance relating to federal gift and estate tax, but also relating to state gift, inheritance, and estate taxes, where applicable. We also offer trust administration and probate services upon the death of a client. As a member of the American Academy of Estate Planning Attorneys, our law firm is kept up to date with information regarding recent legal developments in all areas of estate planning and elder law. You can get more information about a complimentary review of your clients existing estate plans and our planning and administration services by calling our office or by visiting our website.
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