estate of powell: a new example of failed deathbed tax

Estate of Powell: A New Example of Failed Deathbed Tax Planning A WEALTHCOUNSEL PAPER

It has been 12 years since the Fifth Circuit affirmed the Tax Court’s opinion in Estate of Strangi,1 holding that the full, undiscounted value of the assets transferred to a family limited partnership established by a deceased taxpayer was included in the decedent’s estate. Strangi was a victory for the Internal Revenue Service (IRS) in the family limited partnership area.

Strangi turned on the application Internal Revenue Code (Code) § 2036(a)(1), which provides that retained possession or enjoyment of the property or the right to income from the property causes the property to be included in the transferor’s estate upon his death. Because the Fifth Circuit affirmed the decision based on Code § 2036(a)(1), it did not address a related issue involving Code § 2036(a)(2), which provides that the retained right to designate who will enjoy property or possess the income from it can also cause inclusion of the full value of the property in the transferor’s estate. In Strangi, the Tax Court had suggested that the retained right to control distribution decisions or liquidate the entity could cause inclusion under Code § 2036(a)(2). Because the Fifth Circuit held that the assets were included under Code § 2036(a)(1), it did not address the Code § 2036(a)(2) argument.

The recent Tax Court case of the Estate of Powell2 builds on the rationale established by Strangi¸ but ultimately rests on the application of Code § 2036(a)(2). Powell held that a power to liquidate a family limited partnership—exercisable by the decedent’s agent with other family members—gives the decedent control over possession or enjoyment of the underlying assets transferred to the family limited partnership or the income from it. As a result, the full value of the assets transferred to the family limited partnership are included in the decedent’s gross estate. Powell also addressed application of Code § 2043 when Code § 2036 is triggered and application of Code § 2038 to a failed gift under a power of attorney.

The rationale of Powell represents the latest threat to valuation discounts. If broadly applied in future cases, Powell could eliminate many discounts used in valuation planning. This article discusses the Powell decision and provides practical recommendations for valuation planning following the decision.

OVERVIEW OF THE FACTS

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.

ESTATE OF POWELL: A NEW EXAMPLE OF FAILED DEATHBED TAX PLANNING WEALTHCOUNSEL PAPER | 1

Estate of Powell: A New Example of Failed Deathbed Tax PlanningBy: Joseph Percopo, JD, LLM

1 Estate of Strangi v. Comm’r, T.C. Memo 2003-145, aff’d 417 F.3d 468 (5th Cir. 2005).2 Estate of Powell v. Comm’r, 148 T.C. 18 (2017).


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.

The decedent’s estate filed a gift tax return for the transfer to the CLAT. The value assigned to the limited partnership interest received by the decedent was approximately $7.5 million, reflecting a 25 percent discount for lack of control and lack of marketability. The IRS issued notices of deficiency in both estate and gift tax for failure to include the value of the assets transferred to the family limited partnership interest in the gross estate and overstatement of the valuation discount for the transfer to the CLAT.

After the deficiency assessments, the estate moved for summary judgment in its favor that there was no deficiency of either tax. The IRS also moved for partial summary judgment on three different theories:

1. The value of the cash and securities is includible in the decedent’s gross estate under Code § 2036(a)(1) or (2);

2. The value of the limited partnership interest is includible because decedent’s son lacked authority to transfer the family limited partnership interest to the CLAT; and

3. The value of the cash and securities is includible in decedent’s gross estate under Code § 2038.

COURT’S ANALYSIS2036(a) or 2035(a) Inclusion for Transfer to Family Limited Partnership

The IRS argued for inclusion under both Code § 2036(a)(1) and Code § 2036(a)(2).3 The Court agreed with the IRS and held for inclusion under Code § 2036(a)(2), making it unnecessary to consider the Code § 2036(a)(1) argument.

The IRS’s argument for Code § 2036(a)(2) inclusion rested on the “decedent’s ability, acting with her sons, to dissolve [the family limited partnership] and thereby designate those who would possess the transferred property or the income from the property.”4 The IRS argued further that the bona fide sale exception under Code § 2036(a) does not apply because the estate failed to demonstrate a significant nontax purpose for the formation of the family limited partnership.

The estate’s only response to the arguments put forth by the IRS was that “upon her death, decedent did not retain her interest in [the family limited partnership]”5 and therefore it should not be included in her gross estate. The Court dismissed the estate’s argument for two reasons: (1) the argument assumed the transfer to the CLAT was a valid transfer;6 and (2) even if it was a valid transfer, Code § 2035(a) would cause estate tax inclusion because the transfer happened within 3 years of the decedent’s death and the underlying assets would have otherwise been included under Code § 2036(a)(2) but for the transfer.

3 If, after the transfer, the decedent retained for life the right to the income from the property or the right to designate the beneficiary of the property or the income therefrom, then Code § 2036 includes the value of the transferred property in the decedent’s gross estate.4 Powell at 4.5 Id. at 5.6 This particular issue is addressed below in the section on Validity of Gift to CLAT and Application of Code § 2038.


The Court, relying heavily on Strangi, first explained that the decedent’s ability to dissolve the family limited partnership with the cooperation of her sons constituted a right “in conjunction with others”7 to designate the person who possesses or enjoys the property or the income from it. Second, the Court explained that the general partner, as in Strangi, had sole discretion to determine the amount and timing of partnership distributions. The general partner was also serving as the decedent’s attorney-in-fact and was obligated to act in the decedent’s best interest. Therefore, in addition to his duties as a general partner, he “owed duties to the decedent that he assumed either before he created the partnership or at about the same time.”8 Since the decedent owned a 99 percent interest in the family limited partnership, “whatever fiduciary duties limited [decedent’s son]’s discretion in determining partnership distributions were duties that he owed almost exclusively to the decedent herself.”9 Moreover, there was no legitimate business purpose for the family limited partnership. Thus, any fiduciary restrictions on the decedent’s son were “illusory” and “do not prevent his authority over partnership distributions from being a right that, if retained by the decedent at her death, would be described in section 2036(a)(2).”10

The Court distinguished this case, as it did in Strangi, from the Supreme Court’s opinion in United States v. Byrum.11 In Byrum, the decedent retained rights to vote shares of stock in three corporations that he had transferred to a trust for the benefit of his children. The Court, in Byrum, determined that the decedent’s ability to vote did not provide him with the ability to control dividend distributions. The Court reasoned that “as the controlling shareholder of each corporation, [the decedent] owed fiduciary duties to the minority shareholders that circumscribed his influence over the corporations’ dividend polices.”12 Thus, the Court distinguished the Estate of Powell because the family limited partnership did not conduct business and that “[i]ntrafamily fiduciary duties within an investment vehicle simply are not equivalent in nature to the obligations created by United States v. Byrum.”13 Therefore, any fiduciary obligations under state law the decedent’s son may have possessed were disregarded for purposes of determining Code § 2036(a)(2) inclusion.

Limitation Imposed by 2043(a) on Amount Included in Gross Estate

The Court also addressed the application of Code § 2043(a) in the calculation of the gross estate for purposes of Code § 2036. In calculating the amount included in the gross estate the estate must aggregate:

1. the value of the family limited partnership interest retained reflecting any valuation discounts; and 2. the value of the assets contributed in exchange for the family limited partnership interest reduced by the

value of the family limited partnership interest retained by the estate.

The first factor reflects the value of the retained asset in the gross estate by way of Code § 2033. The second factor applies Code § 2043 to reduce the amount included under Code § 2036 by the value of the interest retained by the estate (and already included under Code § 2033), and therefore, prevents duplicate inclusion when calculating the gross estate.

7 Powell at 6 (internal quotes omitted).8 Id. at 7.9 Id.10 Id. 11 408 U.S. 125 (1972). The Court did not include the value of a transfer of a business interest in the decedent’s gross estate because it determined that the decedent had a fiduciary duty to the minority shareholders and could not therefore control distributions unilaterally. 12 Powell at 6.13 Id.


The issue was not raised and went unnoticed by both the estate and the IRS. By addressing this issue sua sponte, the Court provided a new method to avoid duplication of the value of the family limited partnership interest and the underlying assets includable by way of Code § 2036.

Validity of Gift to CLAT and Application of Code § 2038

The decedent’s son was designated the decedent’s attorney-in-fact via a power of attorney. The power of attorney granted him the authority to deal in all property which the decedent owned. It also authorized gifts to a class composed of the principal’s children and their descendants up to the amount of the federal annual gift tax exclusion under Code § 2503(b). The power of attorney also included a ratification clause ratifying and confirming “all that the agent shall do, or cause to be done.”14

The IRS argued that the decedent’s son did not have authority under the power of attorney to make a gift of the decedent’s assets to a CLAT. If he exceeded his authority, the gift was either revocable or void under California law. The estate argued that the general grant of authority permitted him to make the transfer to the CLAT. To support its argument, the estate relied on two cases in which it claimed that the Court had “agreed that an agent had authority to make gifts where the power of attorney for property had language similar to [decedent’s] power of attorney for property.”15

The Court dismissed the estate’s cited cases because each applied the law of another state and, in each case, the Court had interpreted a specific provision in the power of attorney as granting the expressed authority to make a gift. In this case, the Court looked to California law to determine the effect of an alleged gift by an attorney-in-fact. Under California law, a general grant of authority does not provide, in and of itself, the power to make gifts. California courts have long required an express grant of authority to make gifts.

The estate also argued that, even if the decedent’s son did not have actual authority, the transfer was ratified and confirmed under the ratification clause in the power of attorney. The Court also rejected this argument, reasoning that it would obliterate the requirement of an expressed grant of power to gift through a power of attorney.

The Court held that decedent’s gross estate includes the value of the family limited partnership interest either “because the purported gift of that interest was void (so that she held title to the interest upon her death) or because the purported gift was revocable (so that the partnership interest is includible in her gross estate by reason of section 2038(1)).”16

CONCURRING OPINION

The concurring opinion written by Judge Lauber was joined by six other judges. The stated purpose of the concurring opinion was “to emphasize what the Court did not decide and highlight what the Court need not have decided.” 17

14 Id. at 2.15 Id. at 6.16 If the decedent retained at death the right to alter, amend, revoke, or terminate the transferee’s enjoyment of the property, Code § 2038 includes the value of transferred property in the value of decedent’s gross estate.17 Powell at 16.


Judge Lauber explained that the Court did not consider the theory “that the partnership was invalid ab inito.”18 Under this theory, the assets purportedly transferred to the invalid family limited partnership were still owned by the decedent and would therefore be included in her gross estate. However, because this theory was not specifically raised by any party, the Court assumed the family limited partnership was a valid entity and did not address it.

Judge Lauber agreed that Code § 2036(a)(2)’s application was appropriate to include the value of the transferred family limited partnership property in the gross estate. Nevertheless, Judge Lauber argued that he saw no “double inclusion” problem.19 He thought the family limited partnership was an “empty box” holding the $10 million. After application of Code § 2036(a)(2), it is “perfectly reasonable to regard the partnership interest as having no distinct value because it was an alter ego for the $10 million of cash and securities.”20 Therefore, Judge Lauber believed that the Court’s application and discussion of Code § 2043(a) was unnecessary and a “solution in search of a problem.”21 He cautioned, in his parting thoughts, that the Court may inadvertently be “creating problems that [it] does not yet know about.”22

PARTING THOUGHTS

Powell is yet another case in which we find that “bad facts make bad law.” Due to the aggressive deathbed tax planning, the Court could have easily found inclusion in the gross estate of the underlying assets which were transferred to the family limited partnership. This was the approach argued for by Judge Lauber. Instead, the Court took a different path to arrive at the same conclusion.

What is most concerning about the opinion is the Court’s application of Code § 2036(a)(2) based on the decedent’s ability to vote with her sons to liquidate the partnership. If broadly applied, this deals a serious blow to intrafamily planning with family limited partnerships. Most states permit the dissolution of the partnership or LLC if all of the entity’s respective owners consent to the dissolution. If broadly applied by the IRS, this precedent could include in the decedent’s gross estate the value of underlying assets which were transferred to a family limited partnership (or LLC) where the decedent (or his or her agent) with other family member owners can control when the entity is dissolved. This effectively circumscribes valuation discounting.

There are several steps that prudent practitioners can take to help clients avoid the result of Powell.

Avoid Deathbed Planning When Possible

The timing of the planning makes this a classic case of bad facts making bad law. All of the tax planning and transfers were completed within the week prior to the decedent’s death, a mere seven days. The preferred approach would be to plan in advance so as to create a larger gap in time between the estate tax planning transactions and the death of the decedent. This means the planning should occur while the decedent is alive and well, not on his or her deathbed.

18 Id.19 Id.20 Id. at 17.21 Id. at 18.22 Id.


Be Able to Substantiate a Business Purpose

The family limited partnership in Powell lacked a legitimate business purpose. The family limited partnership only consisted of cash and securities, all owners were family members, and the general partners made no legitimate contribution for their interests. The decedent took back a 99 percent limited partnership interest for contributing $10 million and the decedent’s sons took back a one percent general partnership interest for contributing unsecured promissory notes (i.e. nothing of real tangible value). Being able to demonstrate a business interest is important.23 Tax planners can help facilitate this by:

1. Encouraging the family limited partnership to be funded with a diverse set of assets. Property that requires upkeep and management—like rental property—can be ideal.

2. Recommending the general partner take out an interest larger than one percent of the entity. While this would be prudent to apply, the Court did not mention the division of ownership of the entity. This means that it could be interpreted to apply regardless of ownership division.

3. Requiring all contributions to be legitimate and of equivalent value to the amount of equity received for the contribution. An unsecured promissory note may not suffice. If the minority owners do not have capital of equivalent value to contribute, the promissory note should be secured, there should be set payment terms, appropriate rate of interest applied, and actual adherence to the repayment schedule by the notes contributor. Anything less will undermine the legitimacy of the promissory note.

4. Discussing having owners other than family, employees, or any other individual that can be seen as being controlled by the decedent or the decedent’s family. This will likely be a very difficult sell to clients because their goal is to keep the wealth within the family unit and having outsiders involved will likely concern them. Including a charity as a beneficiary may help alleviate this concern and accomplish tax objectives.24 This setup provides a very important distinction from Powell in that the decedent and his or her family cannot control the liquidation.

Consider the Terms of the Partnership Agreement

In Powell, the partnership agreement gave the general partner complete control over timing of distributions and contained no terms limiting the owners’ ability to dissolve the family limited partnership. The terms of the partnership agreement should be carefully considered, including any standard boilerplate language. This may be accomplished by having terms which limit distribution and termination so that a non-family member, who cannot be controlled by the decedent or decedent’s family, must consent to either action.

This is a perfect opportunity to incorporate a non-family owner of the entity as previously suggested above. If, for example, the partnership agreement required all partners to consent to distribution or liquidation, and at least one partner was a non-family member and not subject to control, then a strong argument may be presented against gross estate inclusion because the power of the non-family member cannot be attributed to the decedent or the decedent’s family. The decedent’s ability to control the liquidation of the entity and therefore control who will possess or enjoy the assets is negated by using this technique.25

23 See Estate of Byrum, 408 U.S. 125 (1972), which involved several corporations that were functioning legitimate businesses.24 See Kerr v. Comm’r, 113 T.C. 449 (1999), aff’d 292 F.3rd 490 (5th Cir. 2002).25 Id.

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Carefully Consider Overlapping Fiduciary Roles

It is also important to consider which individuals will serve in multiple fiduciary capacities. In Powell, the decedent’s attorney-in-fact was also a general partner the family limited partnership, which he formed by exercise of his power as trustee of the decedent’s trust. The individual served as attorney-in-fact, general partner, and trustee. This is problematic. How does one draw a line between the different fiduciary duties? Can a general partner act against the decedent’s interest and, at the same time, comply with his fiduciary duty to the decedent under the power of attorney? The solution is simple: use different individuals to serve in different fiduciary capacities (and ideally not all of which are the decedent’s family members).

Ensure that the Estate Plan is Coordinated

The final takeaway is the importance of a comprehensive review of the estate plan. The trust terms, the power of attorney, and the partnership agreement should each be carefully reviewed and crafted to permit accomplishing the decedent’s goals while minimizing and reducing the exposure of estate or gift tax inclusion. An obvious mistake, like making a transfer that was not permitted under a power of attorney, as in Powell, could have easily been avoided with proper counsel. The Court’s decision did not turn on this mistake, but it highlights the importance of proper review.

The more you can help distinguish your client’s situation from that of Powell, the better chance your client will have of escaping a similar result. Remember: Noah built the ark before the rain began to fall. This lesson should be applied in your estate planning for your clients because waiting for the flood to come will likely drown your tax planning.

estate of powell: a new example of failed deathbed tax

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