Central on the mind of estate planners around the country is the status of the federal estate tax. Firms around the country, including our own, have made changes to clients’ plans to take into consideration the possibility that if a client with an otherwise taxable estate were to pass away during 2010 prior to Congress making a change to the tax law, we would be able to effect a plan wherein the entire estate passes free of federal estate tax. On the Jeffrey Burr Blog we have made a coordinated effort not to bore our readers with too frequent discussion of this topic.

Many times people will tell me they don’t need to prepare estate planning documents because they don’t have an “estate.” My response is simply, “you don’t have to have a significant amount of assets to need an estate plan.” Take a moment to ask yourself the questions below to see if you need to consider putting together an estate plan or updating an outdated estate plan:

Do you have current estate planning documents?

1. A Revocable trust that properly addresses changes in familial relationships, financial status, and changes in the law, e.g. the recent appeal of the estate tax.

2. A properly executed pour over will if you have a trust or a simple will if you don’t have sufficient assets to justify a trust. Even if you don’t own a significant amount of assets, having a properly executed will in place can assure that what assets you do have are distributed according to your wishes.

3. Medical directives and powers of attorney specific to your jurisdiction. These documents are especially important and really have nothing to do with the amount of assets you own.

4. Nomination of a guardian for self, estate, and minor children. Again, these nominations have nothing to do with the size of your estate, but have everything to do with properly providing the appropriate individuals to take care of you or your children in the event you are unable to do so yourself.

Are you a business owner?

5. Are you operating as a sole proprietorship? If so, are you properly insured (life and disability) and protected from frivolous liability? Are you performing the legal formalities necessary to achieve limited liability in the event you are operating via a limited liability company (LLC) or limited partnership (LP)? Do you have a contingency plan in place that provides for the management or distribution of business assets in the event of your death or incapacitation? Operating a business through a legal entity has tremendous advantages; however, one must make sure that the entity is maintained properly or such an entity may not provide the expected benefits when the time comes (i.e. do not comingle personal and business assets, have an operating agreement in place, maintain adequate insurance).

6. Do you have partners? If you have partners, it is highly recommended that an operating agreement be in place and that a properly funded buy‐sell agreement accompany the operating agreement. These documents should address liquidation rights, rights to first refusal in the event one partner sells his/her interest in the entity, succession planning, etc.

Are you concerned about asset protection and special needs planning?

7. Do you have a developmentally disabled spouse, parent, child, grandchild or has there been a recent death in the family? It may be important to form a Special Needs Trust to allow a disabled loved one to be able to receive an inheritance from you without hindering his/her chances of receiving governmental assistance. It may also be important to protect yourself from potential creditors of your loved one by putting the proper legal entities in place to hold assets.

8. Do you have any of the following: Children from a prior marriage; a spouse with children from a prior marriage; step children; concerns about children’s spouses; plans of marriage on the horizon.

All of these issues may affect the current estate plan you have and place and should be examined on a case-by-case basis. As you can see, some of these issues have nothing to do with the amount of assets you own or the size of your estate. Everyone should take the time to at least ask themselves: Who will take care of my kids or me, and how, in the event I am not able to care for myself? Asking such a questions may help you realize the importance of putting in place an estate plan that is specifically tailored just for your needs.

While litigation never ceases in the family limited partnership (“FLP”) area of tax law it is exciting to report on two recent taxpayer victories.

First Victory—Estate of Samuel P. Black, (TC, Dec. 2009). In this case, the decedent set up an FLP—Black, LP—and then transferred stock in a corporation (“Erie”), which was also his employer, to the FLP. His philosophy of investment was explained by the court to be one of “buy and hold,” particularly with respect to the Erie stock. Because he purchased the Erie stock at every opportunity, by the 1960s, he was the second largest shareholder.

Mr. Black had gifted stock to his son and to trusts established for his grandchildren. He became concerned that his son might default on a bank loan and that his son’s marriage was heading toward divorce. These factors could cause his son to have to sell some of his Erie stock. He was also concerned that the Erie stock would be distributed to his grandchildren from the trusts and that they might then also sell some of stock. Mr. Black was told that if he established an FLP which included as limited partners his son and his grandchildren’s trusts, he could better keep the Erie stock from being sold without his consent. In 1993 the FLP was formed and Mr. Black was the general partner until 1998, at which time his son became managing general partner of the FLP. Throughout the years, Mr. Black made several gifts of interests in the FLP to his son, to his grandchildren, to the trusts established for the grandchildren, and to a charity. When Mr. Black died in 2001, the FLP still held all of the original Erie stock.
When just five months after he had passed away Mr. Black’s wife died, a secondary public offering was made of the Erie stock wherein the FLP sold three million shares for $98 million, in order to pay estate taxes. The FLP then loaned $71 million to Mrs. Black’s estate to pay estate taxes. The Internal Revenue Service (“IRS”) asserted that the stock in Erie which Mr. Black had transferred to the FLP should be included in his gross estate under Section 2036 of the Internal Revenue Code (“IRC”). It is not clear whether Mr. Black retained any of the proscribed rights under Section 2036; however, the court addressed the bona fide sale exception first. In prior cases, the Tax Court has held that to meet the bona fide sale exception, the decedent must have had a legitimate and significant non‐tax reason for creating the family limited partnership. Under this analysis, the court held for the taxpayer stating that using the partnership to address Mr. Black’s concerns about the Erie stock being sold was such a legitimate non‐tax reason.

Second Victory

Estate of Charlene B. Shurtz (TC, Feb. 2010). Mrs. Shurtz and many members of her extended family (remove the word “members” here) owned significant interests in a timberland holding. She, along with the other family members, were advised by an attorney that having so many owners made management of the timberland difficult and would make a future sale a burdensome and cumbersome event. In 1993 this led to the formation of a limited partnership—C.A. Barge Timberlands, L.P. Family members holding timber interests then contributed their respective interests to the limited partnership in exchange for partnership interests. The limited partnership had a corporate general partner of which Mrs. Shurtz was a one‐third owner.

In 1996, Mrs. Shurtz and her husband formed a family limited partnership—Doulos L.P. (the “FLP”)—for the apparent reason of protecting family assets from potential creditor claims. It appeared that Mrs. Shurtz believed the state where the timber was located was an especially litigious state. Mrs. Shurtz contributed her interest in C.A. Barge Timberlands, L.P. along with other separate timberland that she owned to Doulos L.P. She initially held a 1% general partnership interest and a 98% limited partnership interest in the FLP, while her husband held a 1% general partnership interest. Before passing away in 2002, over the course of several years she made many gifts of small interests in FLP to her children and to trusts established for her grandchildren.

At the time of her death she held a 1% general partnership interest and an 87.6% interest as a limited partner. Even though her estate plan was set up utilize her exemption amount and the marital deduction in such a way that no tax should have been due upon her death, the IRS took the position that the assets she had transferred to the FLP should be included in her estate under IRC Section 2036.

The court accepted the estate’s argument that FLP was formed to protect family assets from litigation claims and to facilitate management, thereby finding that her transfers fell within the bona fide sale exception to Section 2036 of the IRC. Therefore, the court was not required to consider whether she had retained any of the proscribed 2036 rights.

Estate of Samuel P. Black and Estate of Charlene B. Shurtz are both good examples of why it is important to emphasize the non‐tax reasons for entering into an FLP transaction in which ownership in the entity is being transferred from one generation to the next. Some courts are more lenient than others in what they are willing to except as legitimate non-tax reasons, so it is best to have several potential reasons on hand. Also, choosing a non‐tax reason like asset protection may sound great for tax purposes, but could become problematic from an asset protection standpoint if a transfer to an entity is ever challenged and it looks like asset protection was the sole reason for its creation as it may be difficult to argue that said transfer was not made to hinder, delay, or defraud creditors. Alternative suggested non‐tax reasons for transferring ownership of an entity could be: to consolidate control of family owned assets, ease of management and transfer of ownership, facilitation of financing, etc. The bottom line is that each case needs to be addressed separately and legitimate non‐tax reasons specific to a given transaction need to be considered and documented or the client needs to understand the potential exposure he/she faces by not doing so.

For more than ten years, we at Jeffrey Burr have been advocating the use of the Nevada trust statutes for asset protection. Unfortunately, although we are pleased with the number of people who have taken this important step in their planning, most of our clients have not taken advantage of the protection offered with this trust which we affectionately call the “Nevada On-Shore Trust” or “NOST”, with the result that when a client comes to us with the prospect of being sued or incurring a large debt due to foreclosure on a property, we are limited in our ability to provide legitimate asset protection beyond a homestead and some other minor exemptions allowed under the law. Some people mistakenly believe that they can implement asset protection strategies after the events have occurred which may result in loss or liability, and we generally explain that although it is possible that some strategies will work, it is also possible that any post-loss strategies may be set aside by a judgment creditor. It is always best to have bought the fire insurance before the house is discovered to be on fire.