The facts in this case are very convoluted. I will try to simplify and briefly explain the facts that are relevant to the Tax Court's decision.
Mrs. Miller died in May 2003 - the value of her estate is the issue in this case. Mr. Miller (Mrs. Miller's husband) became an avid investor after retiring as an architect. He used technical analysis, e.g. charts, to make investment decisions and developed his own investment philosophy. Prior to his death in 2000, Mr. Miller established two trusts; a revocable trust and a qualified terminable interest trust or QTIP trust. At the time of his death, his revocable trust held $7.6 million in securities and constituted 99.6% of his total estate. Virgil G., one of Mr. Miller's four children, became the executor of Mr. Miller's estate (he is also the executor of Mrs. Miller's estate). Virgil G. funded the QTIP trust with $1 million worth of assets and took a marital deduction for the full amount on Mr. Miller's estate tax return pursuant to section 2056(b)(7).
Two years after Mr. Miller's death, Mrs. Miller and Virgil G. formed the Miller Family Limited Partnership. The purpose of the MFLP was to centralize the management of the family's securities. Mr. Miller trained Virgil G. in his investment philosophy. Virgil G. was charged with managing the MFLP assets using his father's investment philosophy. In so doing, Virgil G. was paid a management fee and worked 40 hours per week managing the investments.
The MFLP distributed 1,000 units. 920 to Mrs. Miller and 20 units to each of the four children which included Virgil G. In April 2002 Mrs. Miller funded the MFLP with two transfers. The first transfer was for $2.7 million in securities. The second transfer was $1.2 million in securities.
The last transfer from Mrs. Miller to the MFLP occurred in May 2003, several weeks prior to Mrs. Miller's death. Mrs. Miller transferred all her remaining assets to the MFLP; in total about $1.2 million.
In total Mrs. Miller transferred about $5.1 million to the MFLP over a period of two years. At her death, she still had the funds from the QTIP which had dwindled to about $.5 million. This at least gets us close to the $7.6 million that the family started with when Mr. Miller died. But I can't totally account for the $7.6 million.
On Mrs. Miller's estate tax return, Virgil G. valued Mrs. Miller's 920 units at fair market value and took a 35% marketability discount. The discount for marketability reflects the illiquid nature inherent in units of limited partnership. For example, if you own stock in a publicly traded company, you can sell that stock and receive cash in three business days. You cannot do the same with units in a limited partnership. It could take weeks at best and probably months to sell your units and receive cash. This time difference reduces the units' value.
The IRS argues three points. First, the fair market value of the QTIP trust should be included in Mrs. Miller's estate since it was excluded under Mr. Miller's estate using the marital deduction. Second, both the April 2002 and the May 2003 transfers should be disregarded, and the full fair market value should be included in Mrs. Miller's estate without discounts, because the transfers were not pursuant to a bona fide sale for adequate and full consideration. If this is the case, then the full fair market value of the transfers will be included in Mrs. Miller's gross estate pursuant to section 2036(a). The purpose of this section, as the Tax Court points out, is to prevent escape from the estate tax by making transfers while a person is living that would normally not take place until that person died. The IRS did not argue in the alternative and challenge the 35% discount, which I think was a mistake.
The Tax Court affirms the IRS's decision on the QTIP and the May 2003 transfer. The taxpayer wins on the April 2002 transfer. The QTIP issue is not worth analyzing in this post; the Tax Court does a very good job starting at the bottom of page 20. Plus it is rather obvious that if the QTIP funding was excluded from Mr. Miller's estate it was going to be included in Mrs. Miller's estate.
In addressing the IRS's first argument, the Tax Court explains that the bona fide sale test is satisfied when the transfer occurs for a non-tax business purpose and the tansferor receives a proportionate interest in the partnership after the transfer. The Tax Court analyzes the substance of the MFLP and determines there was a legitimate non-tax business purpose. It clarifies that the MFLP does not need to be a "business" it merely has to have a non-tax business purpose. The non-tax business purpose test was satisfied by both the MFLP agreement and Virgil G.'s efforts in the years subsequent to its formation. Lastly, Mrs. Miller received 920 units in the MFLP (92%) in exchange for the April 2002 transfer. As a result, section 2036(a) does not apply to the April 2002 transfer.
The May 2003 transfer did not meet the bona fide sale exception of 2036(a). It was logically inferred by the Tax Court that a transfer two weeks prior to Mrs. Miller's death was solely to exclude the amount from her gross estate. As a result, the transfer to MFLP was disregarded. Since the transferred assets are no longer considered part of the partnership, there is no marketability issue to consider, i.e. no discount.