Serial Guest Blogger Comments on Family Limited Partnership Case

Matt Erskine was my first guest blogger.  Now he is back with commentary on an important family limited partnership case.


Another Attack on FLPs: Jorgensen v. Comm’r. 107 AFTR 2011


Erskine Comment: The 9th Circuit Court of Appeals has taken another swipe at the use of Family Limited Partnerships for transferring stock between generations. In this case, the deceased, Erma V. Jorgensen, transferred stock to two Family Limited Partnerships. The Court affirmed the decision of the Tax Court which sided with the IRS position that the entire value of the stock in the FLP should be included in her estate and denied the use of the discounted value, as the Estate alleged.

The Appeals Court affirmed the Tax Court’s using the post-transfer operations of the FLP to determine that the deceased 1) retained some economic interest in the assets of the FLP and 2) the transfer to the FLP by the deceased was not a bona fide sale for good and adequate consideration.

The retained economic interest was based on the decedent writing $90,000 worth of checks from the partnership for her personal expenses (even though there was an attempt to correct this by her accountant when this “error” was discovered) and because $200,000 of her estate taxes where paid from the Partnership.

The bona fide sale defect was based on the facts that:

“The type of assets transferred (marketable securities) did not require significant or active management, there was some disregard of partnership formalities, and the nontax justifications are either weak or refuted by the record (including formation of a second family partnership to hold higher-basis assets for gift-giving purposes, purportedly for the same nontax justifications that the original partnership could have already served).”

This reinforces the high level of scrutiny that FLPs and FLLCs incur by the Courts and the Service and the requirement that not only the set up but the ongoing operations of the entities be done with exactitude to insure that the discounting is not disallowed.

Overall, I cannot see that FLPs should be relied upon now that they are under both legislative and court attack for any long term tax planning.

PAOO Comment - I'm not sure that I go all the way with Matt on rejecting FLP's as a valid tool.  For one thing they  frequently would be a good idea even if there were no discounts.  Jorgensen was definitely a case of poor execution.  In my post on the original case I mention the son's difficulty in "getting his head around" the idea that the partnership wasn't just like a bank account.  The most recent Jorgensen decision was in my backlog of draft posts.  I am planning on looking at it along with a couple of other cases.  Be sure to check out the Erskine and Company blog.

Blame it on the Scrivener

Xianfeng Zhang v. Commissioner, TC Summary Opinion 2011-21

This was a substantiation case.  They mentioned the famous Broadway producer, but only to say that his rule didn't apply.  Taxpayer won on home office, but all his travel expenses were disallowed:

Petitioner testified that he took three separate trips to China for business purposes in 2006—one in June lasting approximately 90 days, another in September lasting approximately 60 days, and a third that began in December 2006 and ended sometime in 2007. Petitioner entered into evidence three airplane tickets for flights from both Beijing to Los Angeles and Los Angeles to Beijing. The dates on the airplane tickets are not consistent with the dates or periods of travel to which petitioner testified. Although petitioner's passport bears customs stamps from both the United States and China, some of the stamps are illegible. The stamps that are legible do not correspond with the dates petitioner testified he was in China for business.

Petitioner did produce several receipts that appear to be for automobile and lodging expenses in China. The receipts, however, are in Chinese and do little to explain petitioner's business activities. The receipts do not satisfy the strict substantiation requirement of section 274(d). Petitioner has failed to substantiate the travel expenses he claimed for his trips to China. Therefore, we sustain respondent's disallowance of petitioner's deduction for travel expenses.

ESTATE OF ANTONIO J. PALUMBO v. U.S., Cite as 107 AFTR 2d 2011-1274

This one looked kind of interesting, not least in part because the dollars are pretty big - over eleven million.  Mr. Palumbo had a will that left the residue of his estate to a charitable trust.  Then his attorney redid his will and there was a "scrivener's error" - poor Bartleby gets blamed for everything.  The new will didn't have a residuary clause.  Managing to die intestate with a valid will is quite a feat, but that's what his son contended.  Finally there was a settlement between the son and the charitable trust. Then the IRS gets into the act and says the settlement doesn't qualify for the estate tax charitable deduction.  The taxpayer won, although the court ruled in late April that the government's postion had enough justification that the Estate could not get attorney's fees.

SMITH v. U.S., Cite as 107 AFTR 2d 2011-1228

Mr. Smith, on the other hand, did get attorney's fees of $78,167.02.  The IRS put him though a lot in resisting his refund claims including claiming that he hadn't filed them and then admitting that they did.  They contested both his net worth (if over $2,000,000 you don't get fees) and that their postion had been justified at some point or other even though they ended up caving.

Desmond D. Conyers v. Commissioner, TC Summary Opinion 2011-25

This was an innocent spouse case where the spouse claiming relief was the husband and the wife was deceased.  The only income on the joint return had been from his roofing business which he pretty much controlled.  His story was:

At trial petitioner testified that sometime after respondent's examination he became aware of large sums of cash withdrawn from two of his bank accounts and that he now believes that his wife had been taking money and fixing the books to support a drug and alcohol addiction. He also testified that payment of the tax in issue would cause him such hardship that his only option would be to file for bankruptcy.


The Court wasn't buying it:

Other than this brief and conclusory testimony, petitioner produced no evidence to support these allegations. In the light of the facts indicating that petitioner knew about the operations of his business and its substantial income, we cannot find that petitioner has proven that he is eligible for relief under section 6015(f).


Abdul M. Bangura v. Commissioner, TC Summary Opinion 2011-23

This seems like a pretty run of the mill clueless taxpayer substantiation case.



In connection with the audit of his 2004, 2005, and 2006 tax returns, petitioner told the examining agent that he was not required to provide the Internal Revenue Service with any records or documentation other than those which had been submitted with his income tax returns. Indeed, petitioner never provided the examining agent with documents of any kind with respect to years 2004, 2005, and 2006 during the audit for those years. Nor did petitioner respond to the IDR for 2007.

 The agent really piled it on assuming that there must have been gross receipts to pay the unsubstantiated expenses.



Although the examining agent used the business expenses set forth on Schedule C in reconstructing petitioner's income, he determined that deductions for these expenses should be disallowed for lack of substantiation. The examining agent also determined that for 2007 petitioner was liable for an addition to tax pursuant to section 6651(a)(1) for failure to file a timely return and an accuracy-related penalty pursuant to section 6662(a).

The Court at least gave the taxpayer a break on that.

Consequently, we hold that the examining agent may not use petitioner's disallowed Schedule C expenses to reconstruct his income. Because of this error, respondent must recalculate petitioner's 2007 unreported income.

When it came to the penalties, though, the Court did not find his argument about being somebody just starting in business and learning through honest mistakes at all compelling.

Yet when asked by the examining agent to provide documentation to substantiate his claimed business expenses, he failed to do so. Petitioner asserted that this was not negligence; rather, “it's more or less when you're starting out doing something, like a medical doctor doing operations or maybe a lawyer representing somebody in the courtroom, you have a lot to learn. You do make mistakes here and there.” We find petitioner's cavalier attitude unacceptable.

Here is the punch line.  The taxpayer was a CPA.  I can hear the Wandering Tax Pro laughing out loud in New Jersey right now, even if he is "down the shore".

Check This List Before You Check Out

Erskine Company the Post 2010 Tax Act Checklist April 15, 2011


This blog is entering a new stage.  I have been soliciting guest posts and some have come in..  I have some promises too.  You know who you are, I won't forget.  I am very gratified to have as my first guest blogger, Matthew F. Erskine

Matthew Erskine is the managing partner of this fourth generation law firm. He focuses his estate planning and trust services practice on serving business owners, professionals, individuals, families, collectors, and inheritors of significant assets. Helping his clients and their families achieve their goals by providing customized solutions. Matt carries on his family’s tradition of integrity, continuity, and service.


Who needs a review of their Estate Plan due to the New Tax Laws?

All clients should have their estate plan reviewed if:

1. Their net worth is $3.5 million ($7 million for a couple) or higher,

2. They own stock or other interest in a closely held company,

3. They own a significant amount of artwork, collectibles, commercial real estate, legacy real estate compounds or other unique assets,

4. They own an interest in a Family Limited Partnership or Family Limited Liability Company, or

5. They may inherit any of these assets.

The Questions to ask:

1. Is the estate plan drafted for maximum flexibility?

a. Look for either a large QTIP or Clayton QTIP election being allowed in the estate tax return,

b. Look for a disinterested independent trustee who has broad powers to distribute income, principal, powers of appointment and to terminate superfluous trusts as the tax laws change.

2. Is the possible use of disclaimers outlined?

a. Does this provide a “backstop” to allow changes to the planning due to changes in the tax laws?

3. Has the $5 Million Reunified Exemption been locked in during 2011 and 2012?

a. Have outright gifts been discussed, either in trust or otherwise?

b. For those reluctant to give away property, have Retained Interest Discretionary Income Trust and Reciprocal Spousal Benefits Trust been discussed?

c. Have Health Education Endowment Trusts and CLATs been discussed to supplement outright gifts in excess of the $5 million?

4. Is there a separate plan for significant unique assets?

a. Is there a management plan and succession plan for collections, real estate and family owned companies?

5. Have FLPs and FLLCs that generate a discount been terminated?

a. Terminate before proposal of disallowance of discounting of fractional interests in FLP of passive investments is likely.

6. Have Discounted Gifts of Tangible Property and Real Estate been considered?

If “no” is the Answer to any of these, then a full Estate Plan review should take place.

For more insight into this and other areas be sure to check out Matt's blog.


I will be continuing with my Monday, Wednesday, Friday committment although I think I will be putting up a lot more as I have a large backlog.  Guest posts will go up on days other than Monday, Wednesday or Friday.

Thanksgiving Without Mom Almost Costs $3,000,000

Estate of Sylvia Riese, et al. v. Commissioner, TC Memo 2011-60

One of the things I often say about sophisticated estate planning techniques is that when they fail, it is often a failure of execution rather than conception.  Someone comes up with a sound plan, the documents that will execute the plan are drafted and then somewhere along the line things are not executed in accordance with the plan.  In this case the taxpayers came out OK anyway, but it still represents a cautionary tale.

The case concerns a QPRT - (Qualified Personal Residence Trust).  The technique allows a taxpayer to make a gift of a future interest in their residence.  During the term of the trust they continue to live in it and are treated for income tax purposes as if they own it.  At the end of the term it is treated as being owned by the benerficiaries or a trust for their benefit.  The advantage of the arrangement is that the donor gets to use todays value of the residence (and we all know real esate only goes up).  In addition since it is ownership of the house in the future that is being gifted the value is discounted to take into account the time value of money. (Remember when money used to earn interest).  The disadvantage is that at the end of the term the donor has to start paying rent, if she wants to keep living in the house.  The purpose of the preceeding discussion is to give context for this cautionary tale.  It is not a comprehensive discussion of the QPRT technique.

Mrs. Riese appears to have had some good estate planning done for her:

Mr. Tucker represented decedent with regard to estate planning and other matters.  In 1999 Mrs. Grimes mentioned to him that decedent was agreeable to some additional estate planning with respect to the residence. In response, Mr. Tucker and Mrs. Grimes began considering the establishment of a QPRT for decedent. Mr. Tucker sent a letter dated September 17, 1999, to Mrs. Grimes explaining the Federal gift tax costs and some of the benefits of establishing a QPRT for decedent. Mrs. Grimes then visited decedent and explained the contents of the letter to her. Decedent asked Mrs. Grimes whether she would directly benefit from the establishment of a QPRT. Mrs. Grimes explained that establishing a QPRT would result in a lower estate tax liability but also that decedent would have to pay gift tax on the transfer and pay rent to live in the residence after the QPRT expired. Decedent agreed that a QPRT would be acceptable and gave Mrs. Grimes permission to proceed.


There was good execution on the front end:

On April 19, 2000, decedent established the Sylvia Riese QPRT (the QPRT) under section 25.2702-5, Gift Tax Regs., and executed a deed transferring the residence thereto. Decedent reported the transfer of the residence to the QPRT on Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, for tax year 2000.

Things went awry when the trust reached its termination date.  At that point the trust should have deeded the property to the remainder beneficiaries (new trusts in this case).  The new owner or owners then should have taken responsbibility for paying all expenses related to the property.  Since Mrs. Riese was still living in the property she should have signed a lease and started paying rent.  That's not exactly what happened.

The QPRT agreement states, in pertinent part, that if the settlor (i.e., decedent) survives the termination date of the QPRT, the QPRT shall terminate and the balance of the trust fund (i.e., the residence) shall be distributed 50 percent each to two trusts, known as the 1997 Property Trusts (the Property Trusts), which decedent established in 1996 for the benefit of Mrs. Grimes and Ms. Zipp. The QPRT terminated by its terms on April 19, 2003. Decedent (or the QPRT) did not execute a deed transferring the residence to the Property Trusts.


Mrs. Grimes never discussed rent directly with decedent after the QPRT terminated. However, around the termination date Mrs. Grimes called Mr. Tucker inquiring about how to determine the proper amount of rent to charge decedent. She testified: “I knew she'd agreed to it and, you know, I didn't—I didn't want to feel like I was badgering her. And so I called *** [Mr. Tucker].” Mr. Tucker explained to her that fair market rent could be determined by contacting local real estate brokers and that this could be done by the end of the year (i.e., December 31, 2003). Mr. Tucker entered a “tickler” in his pocket calendar to remind himself to call Mrs. Grimes by Thanksgiving to make sure everything was taken care of.

The significance of Thnaksgiving is unclear.  Perhaps the plan was to get Mom to sign a rent check before the turkey was carved.  Sadly, Mrs Reis did not even make it to Haloween as she suffered a stroke and died on October 26, 2003.  She would not be able to sign a rent check covering the period that she was a tenant rather than an owner as the ball descended in Times Square as Mr. Tucker apparently had planned.

It is unusual for landlords to let people live in a house for 6 months without paying any rent.  The IRS contended that Mrs. Reis had not really given the house away.  People realize that they can't take it with them, but their preference is to control it till slightly before their last breath and then have it go to their heirs without being included in their taxable estate.  There are laws in place to frustrate this natural desire and the laws will take note of implicit understandings.

The Tax Court ended up cutting the family quite a bit of slack:

We find as a matter of fact that there was an agreement among the parties for decedent to pay fair market rent, the amount of which was to be determined and payments to begin by the See Diaz v. Commissioner, 58 T.C. 560, 565 (1972) end of 2003. (basing analysis upon evaluation of the entire record and credibility of witnesses). The Secretary had not issued any regulations or guidance as to how and when rent should be paid upon the termination of a QPRT. We believe that doing so by the end of the calendar year in which the QPRT expired would have been reasonable under the circumstances.


Unlike many cases involving the transfer of a personal residence where the decedent continued to live in the residence until death, see, e.g., Estate of Van v. Commissioner, T.C. Memo. 2011-22 [TC Memo 2011-22], the existence of an implied agreement in this case is negated by the express agreement among the parties for the payment of rent. Many factors, e.g., the creation of the QPRT, the payment of gift tax upon the transfer of the residence to the QPRT, the several instances in which decedent agreed to pay rent, the fact that Mrs. Grimes called Mr. Tucker upon the QPRT's termination to find out how to determine the amount of rent to charge, and Mr. Tucker's corroborating testimony, all lead us to find that there was no agreement or understanding that decedent would retain an interest in the residence for life without paying rent.


We believe that Mrs. Grimes, on the advice of counsel, intended to and would have determined fair market rent by the end of 2003 and decedent would have paid rent. We believe further that Mr. Tucker would have made sure a lease was executed, rent was determined, and all appropriate changes were made to effect the change of ownership. Unfortunately, decedent died unexpectedly in October before any of this occurred.

There was a deficiency of over $3,000,000 involved in this case so I'm willing to wager that the litigation cost was substantial.  Although the taxpayer prevailed (They lost on some other small issues) it must have been kind of nerve racking.  It could have been avoided if when the gift was made in April of 2000, a plan had been made to sit down with Mrs. Reis in say February of 2003 to go over what would be happening in the next couple of months.  The rent determination, the transfer, the lease and the initial rent payment should have all been done in April 2003.

Other practitioners might read this case and come to the opposite conclusion saying that it proves that waiting till the end of the year to clean everything up is just fine based on:

The Secretary had not issued any regulations or guidance as to how and when rent should be paid upon the termination of a QPRT. We believe that doing so by the end of the calendar year in which the QPRT expired would have been reasonable under the circumstances.


I would disagree with that analysis.  There is no reason to take chances like that with so many dollars at stake.

Survey Says - No Discount for Family Limited Partnership

   LEVY v. U.S., Cite as 106 AFTR 2d 2010-7205, 12/01/2010

Sometime in the last millennium there was a TV situation comedy called Angie.  It was about the early days of a marriage between a fellow from a very wealthy Philadelphia family and a waitress from a family of more modest circumstances.  In one of the episodes the two families compete on the game show Family Feud.  Family Feud is a wonderfully egalitarian contest.  Unlike Jeopardy, which requires you to come up with the one correct answer (Expressed in the form of a question)  the questions in Family Feud are matters of opinion.  If you get one of the top five or ten answers (something like that) that were determined by a survey you get some points.  The more common the answer you come up with the more points it is worth.

I forget how the Angie episode worked out in its entirety, but at least early on the husband's wealthy family (including the butler of course) was getting creamed.  People in the survey did not have champagne and caviar for snacks or start the day by checking stock prices.  At one point the host goes up and explains to them that the survey answers come from average people not the ultra wealthy.  They don't get it.  The lawyers for the Estate of Meyer Levy might have learned something from watching that episode, but they were probably studying hard in law school or taking polo lessons, the better to meet wealthy clients, while I was squandering my time learning life's lessons by watching television.

The case was a family limited partnership case.  Family limited partnerships can be a good idea for a multitude of reasons.  They are particularly attractive to people, who not, yet, having come up with a way to take it with them, want to control it all till they draw their final breath without having it all included in their taxable estate.  There's also the asset protection and as they say on Seinfeld yada yada yada.  The thing that people get excited about, though, is the discounts.  That's what the IRS gets excited about too.  Take a bunch of stuff and put it into a family limited partnership.  Say its a million dollars worth of stuff.  Now give 10% of the partnership to your kid.  How much is the gift worth ?  $100,000 ?  Do you think I would pay $100,000 for it ?  Of course not..  As a limited partner I don't get to vote.  On top of that your kid doesn't even have the right to sell it to me.  You have to hire a valuation expert to value the limited partnership interest (I sometimes think the estate tax is, in reality, a white collar jobs program).  She'll tell you its worth something like $65,000, more or less, depending on well yada yada yada. The IRS doesn't like this and is constantly attacking it.

Until recently they focused on poor execution which I discussed at length in one of my early blog posts.  Assets aren't really transferred to the partnerships.  Personal bills are paid directly by the partnership.  Distributions are not made in proportion to partnership ownership.  Tax returns are not filed or not done correctly.  In a more recent case, Fisher, discounts were not allowed for a single asset partnership, because it lacked business characteristics.  There was no discussion of flawed execution. 

No discount was allowed to the Estate of Meyer Levy for the sale of its Plano real estate that was in a partnership.  The estate appealed the verdict alleging error on the part of the trial court.

The Estate argues that the trial court erred when it allowed the admission of


 (1) evidence of the ongoing negotiations over the sale of the property, specifically the offers and proposals;
(2) evidence of the listing price of the property, and the ultimate sale price of the property;
 (3) valuation testimony by the Government's expert based on flawed methodology; and
(4) opinion testimony by a lay witness and hearsay testimony.

Wow.  In a valuation case they considered what people were offering for the property and what it actually sold for.  That's pretty outrageous.  You see the problem was it wasn't a judge that had to think about these things.  It was a jury.  Who ends up on a jury ?  I'm not sure exactly. I suspect that they have more in common with the people Family Feud surveys for its answers than the people I run into at tax conferences.


The Estate contends that the jury arbitrarily disregarded unequivocal, uncontradicted, and unimpeached testimony of an expert witness, bearing on technical questions of causation beyond the competence of lay people. The Government counters that the jury had the partnership agreement in evidence from which it could have determined that there was no lack of control or marketability.

The record contains ample evidence to support the jury's verdict valuing the property at $25 million. The Estate listed the property, and eventually sold the property, for $25 million. It was immediately resold for $26.5 million. Sophisticated developers with no stake in the current litigation engaged in ongoing negotiations for the property for prices in the $20–25 million range. The Estate's expert testified that the market in Plano remained relatively flat during the period between Levy's death and the sale of the property. Also Jordan testified regarding the value of the property. Any of these provides sufficient support for the jury's verdict on the property.


The jury verdict regarding the discount also finds support in the record. The partnership agreement itself would be sufficient evidence. The jury could have rationally found that no discounts for lack of control or marketability were merited because the Estate controlled the general partner interest, which had nearly unfettered control over the Partnership's assets. The trial court did not abuse its discretion when it denied the Estate's motion for new trial.

I'm not a lawyer and I don't even play one on TV.  I prepare and review tax returns and do tax planning.  I also represent people who are being audited by the IRS, but there I'm generally dealing with accountants.  If my clients end up in Tax Court and win I'll still think that I lost.  I am fairly certain though, that it was the choice of the estate's lawyers to bring this matter to a jury.  To have that privilege, they had to pay at least part of the tax in order to be able to sue for refund in district court.  They could have instead gone to Tax Court where they would have had people who dealt with "technical questions beyond the competence of lay people" all the time and frequently allow discounts.  Somehow though they thought they would do better with a jury.

Apparently though the government lawyers saw to it that the jury found out that the Estate got $25,000,000 and these simple minded people thought that might be indicative of whatever the estate had was worth.  I suppose there was some sort of trial strategy that would keep this information undisclosed.  In which case the jury would have had to weigh the government's yada, yada, yada against the Estate's yada, yada, yada.  There might have been some logic to that.  If I was playing Family Feud and the question was "Name a class of people that are very popular" I would venture neither multi-millionaires or IRS agents.  If the question was "Name a class of people that are despised"  I think I might score higher with "IRS agents".  I mean no disrespect to IRS agents, their unpopularity is inherent in their jobs. 

In  a refund suit in district court either the government or the taxpayer can ask for a jury.  I haven't been able to figure out which it was.  I did find that the executor had been a potential candidate for mayor of Austin Texas and the late Mr. Levy had established a fairly well known charitable foundation.  So there may have been a feeling that there was a home town advantage.  There was also a sense in which the Estate was playing with the house's money if it was the one that gambled on a jury, as is noted in a footnote:

Although we have declined to set aside the jury's verdict of zero discount, we note that the actual discount applied in taxing the Estate was thirty percent. Given the valuation found by the jury, it would have had to find a discount of larger than thirty percent for the verdict to make a difference to the judgment in this case.



I don't know whether this case will have a chilling effect on family limited partnerships or not.  My cumulative sense is that you should only do them if you think they are a good idea anyway.  Oddly enough, that will make it more likely that you will succeed on the discount issue.  I think the key planning point to take away from the case is the Court's comment that it would have been reasonable to find a zero discount because of the Estate's general partnership interest.

Devil is in The Details

In June of 2007, the Estate of Sylvia Gore joined the ranks of failed Family Limited Partnership. The case is worthy of consideration, because it illustrates clearly why the partnerships fail. If you are going to set up a family limited partnership it is critical that you consult with a well qualified attorney. The attorney will create a package, more or less thick, of documents, more or less mysterious and will see that you sign them with witnesses, notarized, with an extra copy in her safe in case you lose yours. That’s service. That’s follow through. Valuation discounts are what tends to be at stake when the IRS attacks Family Limited Partnerships. Having had great service from your attorney, you probably think that when people lose it is because they didn’t hire a good attorney. Perhaps the documents weren’t witnessed. Maybe one of the incantations in the mysterious documents was missing. Maybe there wasn’t an extra copy in the safe, after they lost theirs.

The follow through needed is not the extra hour in the attorney’s office. The follow through will be many hours year in and year out in your accountant’s office. The clue to this is in the importance attributed to the extra copy in the attorney’s safe. Why doesn’t the accountant who has to prepare the income tax return for the partnership have a copy? Why don’t you need to look at your copy from time to time too? Here’s why:

each partner's capital account is increased by (1) the amount of money contributed by him to the partnership, (2) the fair market value of property contributed by him to the partnership (net of liabilities that the partnership is considered to assume or take subject to), and (3) allocations to him of partnership income and gain (or items thereof), including income and gain exempt from tax and income and gain described in paragraph (b)(2)(iv)(g) of this section, but excluding income and gain described in paragraph (b)(4)(i) of this section; and is decreased by (4) the amount of money distributed to him by the partnership, (5) the fair market value of property distributed to him by the partnership (net of liabilities that such partner is considered to assume or take subject to), (6) allocations to him of expenditures of the partnership described in section 705(a)(2)(B), and (7) allocations of partnership loss and deduction (or item thereof), including loss and deduction described in paragraph (b)(2)(iv)(g) of this section, but excluding items described in (6) above and loss or deduction described in paragraphs


This is one of the magic incantations that will appear in your agreement. If you ask your attorney how that paragraph should be reflected on the partnership’s tax return, he is likely to tell you that he doesn’t prepare partnership returns. That’s what accountants do. Now go to your accountant and ask her what that paragraph means. Among the possible answers are “That’s some stuff the attorneys have to put in the agreement. Why don’t you ask him what it means?”

So what did Sylvia Gore and her advisers do or fail to do that cost the estate $1,071,650 in federal estate taxes. Plus ten years of interest. Not to mention the cost of their fruitless efforts in the Tax Court.

In 1995 Sydney Gore met with his accountant in the hospital where he expressed to her “his concerns about preserving the wealth he had accumulated through his life's work, protecting his assets from waste, and conserving them for future generations”. The accountant had an idea, a very good idea. Form a family limited partnership. She’d never advised any of her other clients to take that step, but it seemed to the right thing to do here. She knew that she had limits, though:

“Ms. Bowers had little experience with family limited partnerships and had never recommended one to a client before she made the proposal to the Gore children, so she recommended that Ms. Powell, Mr. Gore, and decedent retain an attorney to further advise them about a limited partnership”

Apparently it didn’t occur to anybody that an accountant with more than a little experience with family limited partnerships might be able to bring something to the table.

What happened from here can hardly be blamed on the accountant. The partnership opened a bank account into which substantial sums were deposited. There was an assignment of marketable securities to the partnership. Unfortunately, title to the securities was not transferred to the partnership. The dividends from the securities were not deposited in the partnership’s bank accountant. When Mrs. Gore’s bills need to be paid they were paid sometimes from her personal accounts other times from partnership accounts.

Eventually returns need to be filed, which is when Ms. Bowers came back on the scene. What she did was what most competent accountants would try to do. Observing that what actually happened was not anything near like what was supposed to happen, she attempted to fix it all with journal entries. This process relies on one of the great intellectual breakthroughs that built the modern world – double entry bookkeeping first documented in a mathematical treatise over 500 years ago. It provides a built-in check that shows that you captured everything. It all has to balance. Debits equal credits.

When a check is written we credit cash. Then we have to debit something. Well the check went to Mary, so we debit Mary’s capital account. Unfortunately, by the terms of the partnership agreement we were not supposed to make a distribution to Mary. So we debit “Due from Mary”. Joe, on the other hand was supposed to get a distribution. Well either we won’t worry about that since it’s reflected in Joe’s capital or, if we want the percentages to be where they should be, we will credit “Due to Joe” and debit his capital account. When it’s all done the amounts on our records will agree to the statements (adjusted for the fact that they may not have the right names on them) and “it will all balance.” Mary will owe the partnership and the partnership will owe Joe. We’ll straighten it out next year or we’ll keep making journal entries to keep it straight.

I have learned a hard lesson that many accountants never quite get. When it comes to this “everything’s in balance” routine, almost nobody else cares. Here is some of what the court had to say about Ms. Bower’s efforts:

“The GFLP accounting records prepared by Ms. Bowers purport to show that decedent transferred ….”

“The accounting records also purport to show that after decedent executed the assignment, decedent allegedly sold the Commercial Federal CD, the savings bonds, a Valley National CD, and one of the Treasury notes to GFLP in exchange for a note payable to her from GFLP …”

The word “purport” or one of its forms (e.g. “purporting”) occurs six times. Here is the problem. You can get into law school with a liberal arts degree. They don’t teach double entry accounting in law school. If it’s taught in high school, it’s to kids not on the college track. You certainly don’t need it for a liberal arts degree. Judges are lawyers. It all balances and they don’t care.

I have no reason to doubt that if I looked at all the statements and agreements, I’d have concluded that Ms. Bower’s journal entries straightened things out. Likely most other accountants would reach a similar conclusion when they see that the cash ties and “it balances”. Much to our professional frustration, almost nobody else, but especially the judge, cares. The meticulous journal entries that “straighten” everything out in our minds, in the mind of the judge “purport”.

Also this year, the Estate of Concetta Rector lost to the tune of $1,633,049 plus about five years of interest. Here is an excerpt:

“The estate attempts to downplay the significance of the direct use of RLP funds to pay decedent's personal expenses by attributing that use to “errors”. In the light of John Rector's extensive financial expertise and his testimony that it never occurred to him that RLP should be reimbursed for such “errors” after they were discovered, we find that this argument lacks credibility”
This is nothing new. If you study the cases where taxpayers lose FLP cases, you will, almost always, if not inevitably, find that the failure was not one of a flawed plan. The failure was not following the steps transaction by transaction. If somebody is entitled to a distribution and has bills to pay, you distribute to them and let them pay their own bills. All entities have accounts and the payments in and out are the ones that belong to that entity. If a mistake is made it is fixed by a transfer of funds, not a journal entry that creates an indefinite “Due to”.
The moral of the story is that in order for the plan to work you must have coordination between the attorney who prepares the plan and the accountant who will be preparing the relevant returns. If you don’t want to trouble yourself with what entity should pay what bill or accept what deposit, etc, let that piece be handled by your professionals, also, but again in an integrated manner. There has to be somebody who cares what account is used, because that is their job.