Estate of Powell: Valuation Discount Concerns and Other Takeaways

A new case from the Tax Court has practitioners considering the future of valuation discounts in estate planning. The Tax Court, in deciding Estate of Powell (2017), relied heavily on the Estate of Strangi case that was affirmed by the Fifth Circuit in 2005. The Strangi case analyzed Internal Revenue Code § 2036(a)(1), providing that retained possession or enjoyment of property or right to income from such property causes the property to be included in the transferor’s estate upon death. However, in Strangi, the court did not address the implications of § 2036(a)(2), providing that the retained right to designate who will enjoy property or possess the income can also cause inclusion. What does it mean to have the “retained right to designate who will enjoy property or possess the income?”

In the Powell case, the court found that the power to liquidate a family limited partnership—exercisable by the decedent’s agent with other family members—gives the decedent the requisite control over possession or enjoyment that would cause inclusion of the property in the decedent’s estate under § 2036(a)(2). This is obviously problematic as often one of the primary purposes for transfer of the property to the family limited partnership is to benefit from a reduced value based on lack of control and marketability for Estate Tax purposes. What does this mean for valuation planning in an Estate context?

Powell is a Prime Example of Bad Facts Make Bad Law

A brief overview of the facts in Powell quickly bring to light some glaring problems with the “estate planning” (if it can even be called that, it would be more accurate to call it “deathbed planning”) for the decedent.

Powell involved a family limited partnership agreement that gave the decedent’s son sole discretion over distributions and permitted dissolution upon consent of all partners. Two days after the partnership agreement was signed, the decedent’s son, acting as trustee of the decedent’s revocable trust, transferred $10 million of cash and securities from the trust to the family limited partnership in exchange for a 99 percent limited partnership interest. The decedent’s two sons contributed unsecured promissory notes in exchange for a shared one percent general partnership interest.

On the same day as the transfer to the family limited partnership of the cash and securities, the decedent’s son, acting under a power of attorney, transferred the 99 percent limited partnership interest into a Charitable Lead Annuity Trust (CLAT). The CLAT provided an annuity to the decedent’s private foundation. Upon the decedent’s death, the remainder of the CLAT was to be divided evenly among her two children. One day prior to the transfer to the CLAT, the decedent was determined to be incapacitated by two physicians. The decedent passed away seven days after the family limited partnership was funded.

Based upon these facts the IRS argued that the decedent had the ability, acting with her two sons, to dissolve the family limited partnership and thereby designate those who would possess the transferred property or the income from the property. Thus, the value of the property should be included in the decedent’s estate under § 2036(a)(2). The use of family limited partnerships for purposes of valuation discounts is common, but these partnerships typically provide for dissolution upon agreement of all members as allowed under most states partnership laws. However, the Court’s decision in Powell if broadly applied could complicate valuation discounts. It will be interesting to see if Powell will be affirmed and how it will be applied in the future. Powell certainly does not spell the end of valuation discounts but it does raise some important issues.

What You Can Take Away From Powell

The number one take away from this case would undoubtedly be, if there is a possibility that you might have a taxable estate, PLAN EARLY. It is impossible to emphasize this point enough. The more time you have to be able to establish and execute a plan the more planning options are available and the less aggressive the plan will need to be to appropriately achieve your goals. It is never too early to begin working with an estate planner. While it may not be obvious to everyone, the fact of the matter is, it is far more difficult to transfer $20M over the course of a month or less without Estate Tax consequences than to transfer than same $20M over the course of 5 or more years without Estate Tax consequences.

Another great take away from this case is to work closely with your estate planner and help them to be as familiar as possible with your particular estate picture. The more your estate planner knows the better they will be able to recommend solutions that will achieve your goals. Many of the mistakes made in the Estate of Powell case can be avoided by planning more than a week in advance of the estate holder’s passing.

Contact the Estate Planning professionals at Castro & Co. today if you have any further questions on about Valuation Discounts in Estate Tax planning. We have attorneys ready to assist with Estate and Gift Tax Planning Domestically and Internationally.

Related Posts
  • Understanding Capital Gains on Inherited Property | Castro & Co. [2023] Read More
  • Irrevocable vs Revocable Trusts Read More
  • How Does a Medicaid Trust Work Read More