Many wealthy families use family partnerships as part of their estate planning. A minority interest in a family partnership is worth less than the value of the underlying assets because a third-party buyer would not pay full value for assets controlled by somebody else. When the tax law respects this discount, it can reduce estate and gift taxes. But you have to do it right. If not, the tax law ignores the partnership and includes its assets in the contributing partner’s taxable estate.
Paul Liljestrand was born in Waterloo, Iowa in 1911. He didn’t linger. He went to China with his parents when he was four, and eventually settled in Hawaii after becoming a physician. He apparently had a successful enough career that he needed to do some estate planning. When well into his 80s he formed the Paul H. Liljestrand Partners Limited Partnership (PLP). But the execution went awry.
What went wrong? According to the Tax Court:
-Nobody told the tax preparer that there was a partnership at first, and so no partnership return was prepared for its first two years.
– Dr. Liljestrand contributed so much of his net worth to the partnership that he didn’t have enough other assets to live on. As a result, he used the partnership assets to pay his living expenses.
– There was only one meeting of the partners between its formation in 1997 and the taxpayer’s death in 2004.
– They didn’t treat the partnership in a businesslike way. Partners withdrew cash without executing loans and without formal action or documentation.
– The estate failed to convince the Tax Court that there was any non-tax reason for the partnership.
These are all bad facts. The judge decided that the partnership should be included in the taxpayer’s estate (my emphasis):
The record is devoid of any significant change in Dr. Liljestrand’s relationship with the assets before his death. Dr. Liljestrand received a disproportionate share of the partnership distributions, engineered a guaranteed payment equal to the partnership expected annual income, and benefited from the sale of partnership assets. The objective evidence points to the fact that Dr. Liljestrand continued to enjoy the economic benefits associated with the transferred property during his lifetime. With regards to Dr. Liljestrand’s motivation for forming PLP, Dr. Liljestrand was concerned with the disposition of his property after death. The estate claims he wanted to protect the property from partition and guarantee Robert’s management of the property after his death. These motives are primarily testamentary in nature. The objective and subjective evidence lead to a conclusion that the partnership was simply a vehicle for controlling Dr. Liljestrand’s property after his death.
In summary, we are satisfied that PLP was created principally as an alternate testamentary vehicle to the trust. Taking this feature in the light of all the factors discussed above, we conclude that Dr. Liljestrand retained enjoyment of the contributed property within the meaning of section 2036(a).
As a result, the Tax Court upheld a $2,573,171 assessment of additional estate tax.
The Moral? If you are going to use a family partnership for estate planning, you need to do it right. You want to have a non-tax use for it. You need to respect the formalities, including documentation of activity, maintaining a bank account, and following the partnership agreement. And you can’t use it for all of your assets. If you don’t leave enough assets outside the partnership to finance your lifestyle, you pretty much guarantee that your estate plan will fail.
Cite: Estate of Paul H. Liljestrand, T.C. Memo. 2011-259.