April, 2008 Newsletter
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Mirowski – Owen Fiore's Commentary
We just published a commentary on this case by Mil Hatcher (LISI Estate Planning Newsletter # 1267). Later in the week, we'll be following up with a Paul Hood review. Each of these authorities adds to the lessons LISI members can learn from this very important FLP case.
Here's the story – from Owen Fiore's perspective:
After the 9th Circuit Court of Appeals decision in Estate of Bigelow v. Commissioner last September and the Tax Court opinion in Rector v. Commissioner in December, 2007, taxpayers and their advisors needed some positive reinforcement in the FLP/LLC planning area. That has arrived with the issuance of Tax Court Judge Chiechi's opinion in Estate of Anna Mirowski on March 26, 2008 – a taxpayer victory under IRC Sections 2036(a), 2038(a)(1), and 2035.
A "good facts" case for a change, the 85 page Tax Court opinion (evenly divided between Findings of Fact and the Court's Opinion) goes into great detail on provisions of the LLC operating agreement and rejects with a reasoned opinion the many contentions of the IRS IRS.
Owen G. Fiore, who operates his consulting practice, FioreWealthPlanningConsulting , based in Idaho (http://www.owenfiore.com/) provides his summary of the Mirowski case and its impact on FLP/LLC planning.
Owen tells us that "Good facts, good lawyering, and a good judge provide an unbeatable combination!"
Decedent Anna Mirowski died suddenly on September 11, 2001(the infamous date of terrorist attacks on the U.S.) just a few days following formation and funding of an LLC, as well as subsequent gifts of an aggregate of 48% in LLC interests therein to trusts for her three daughters. The asserted estate tax deficiency of $14.2 million related to this large value LLC involved issues under both IRC Sec. 2036(a)(1) and 2036(a)(2), Sec. 2038(a)(1), the "bona fide sale" exception under the foregoing provisions, and also IRC Sec. 2035.
Finding significant and real non-tax purposes for the LLC plan, determining that the daughters' testimony was credible and on a point-by-point basis rejecting all the IRS's contentions on the legal issues, Tax Court Judge Chiechi determined the LLC viable, the gifts were separate transactions to be respected as such, and that Service reliance on prior "bad facts" cases was misplaced.
A particularly important quote from the Mirowski opinion, illustrative of the court's analysis, is the following, at page 50, footnote 44:
"On the record before us, we find that Ms. Mirowski's significant and legitimate non-tax purpose in forming and funding MFV of ensuring joint management of the family's assets by her daughters and eventually her grandchildren, standing alone, is sufficient to satisfy the requirement that, in order to qualify for the exception in sec. 2036(a) for a bona fide sale for an adequate and full consideration in money or money's worth, there must be a legitimate and significant nontax reason for creating the entity in question."
Decedent and her physician husband had a long history of having and encouraging a close knit family, having three daughters and regularly taking an annual family vacation which included family meetings considering business and investment matters and often involving accountants and attorneys as invitees.
Dr. Mirowski had been developing an implantable defibrillator device and to pursue its development and funding, the family moved to the U.S. in 1968, and within 10 years Dr. Mirowski was successful in developing an implantable cardioverter defibrillator(ICD) thereafter achieving success with implantation in humans.
The ICD patents were jointly held by Dr. Mirowski and a co-inventor, 73% of the royalties for use of the patents being Dr. Mirowski's share. This invention was the primary basis of the development of the wealth of the Mirowski Family.
Upon his death in 1990, Dr. Mirowski, per his Will, left his interests in ICD patents, the patent licensing agreements and all other assets(except to the extent of $600,000) to his wife, Anna.
Decedent had a long and continuing history of making gifts to family members and friends, as well as the making of charitable gifts and establishing a family foundation.
Her daughters each had two children, and important to decedent was that the family remained close-knit in every way, including as to the ownership and management of family wealth.
In 1992, decedent created several irrevocable trusts, one for each of her daughters, with the trustees of each trust being the three daughters. Mrs. Mirowski desired that the daughters to work together and to have a close relationship, including on financial matters. In both 1992, fractional interests in the patent licensing agreements were gifted by decedent to these trusts so that decedent then had a 51.09% interest therein
Following her husband's death, the patent royalties increased quite substantially, to millions of dollars per year.
Mrs. Mirowski at all times was an astute and involved financial manager, as stated by the court, "a careful, deliberate and thoughtful decision maker, especially with respect to financial matters." She worked with an investment advisor at Goldman Sachs to handle a rapidly growing investment portfolio, eventually agreeing to the principle of diversification, and in early 2001 consolidated all investments with Goldman Sachs.
With one of her daughters suffering from chronic epilepsy, decedent embarked on considering ways to provide for the daughters and their children on an equal basis and to insure the daughters worked cooperatively together.
The concept of using an investment entity, here a limited liability company (LLC), as a vehicle for pooling of family assets first came up during a presentation to decedent by U.S. Trust. Thereafter, the family attorney, on August 31, 2000, provided draft articles of organization and an operating agreement for the proposed LLC; however, there was about a year's delay since decedent usually waited for the annual family meeting to consider major decisions so as to involve her daughters in considering same. Thus, it was August 14, 2001 before the LLC plan was reviewed with the family members, and in the meantime, Mrs. Mirowski was suffering from a foot ulcer and was being treated for this affliction considering her diabetic condition. However, her overall health had not, and was not, deteriorating.
The LLC documents were finalized following the August 14, 2001 meeting, and now, beginning at page 18 of the Tax Court's opinion, the findings of fact chronicle the purposes of the LLC, the steps in formation and funding, the gifts by the initial sole member, the decedent, of 16% interests in the LLC to each of the daughter's trusts, all leading up to the sudden September 10, 2001 deterioration of decedent's health and her death the next day, the infamous 911 tragedy.
It was considered important by Judge Chiechi that Mrs. Mirowski " valued the family cohesiveness that joint management of a family business can foster", based to some extent on her early life experience with a family business in France.
August 22, 2001 was the date the final LLC documents were sent to the decedent for signature, together with a cover letter titled "Re: Business, Financial & Estate Planning Matters." Decedent executed the documents August 27th, the appropriate State of Maryland filing of the articles of organization occurred on August 30th, then on September 1, 5, 6 and 7, decedent made substantial transfers of her assets to the LLC of which she was the sole member.
The asset transfers included the ICD patent interests and her remaining 51.09% interest in the licensing agreements, securities valued at $60.5 million, and additional securities plus cash totaling $1.5 million. Thereafter, always contemplating gifts to her daughters' trusts, decedent on September 7th gifted a 16% interest in the LLC to each of the three trusts – thus at that point retaining a 52% LLC interest.
Unfortunately, on August 31st Mrs. Mirowski was readmitted to the hospital for further treatment of her foot ulcer. She resisted suggestions of amputation, but the family and doctors believed she would recover, and as stated by the court in its findings:
"At no time before September 10, 2001, did Ms. Mirowski, her family, or her physicians expect her to die."
However, on September 10th her condition worsened suddenly, and she died, as indicated above, on September 11, 2001.
With this detailed factual background, we now can turn to the Tax Court's analysis of the issues before it, involving the Service allegatikons that Secs. 2036(a), 2038(a)(1), and/or 2035 should apply to achieve the Service-desired result of ignoring the LLC(Mirowski Family Ventures, or "MFV"), and including in decedent's gross estate all assets transferred to MFV. As we will see, IRS IRS contentions were rejected by the Tax Court in this case, and there are significant lessons to be learned from the court's analysis and opinions on the contested issues.
TAX COURT ANALYSIS AND CONCLUSIONS.
The Tax Court identified the issues for its resolution as involving whether the assets of MFV should be includible in decedent's gross estate for estate tax purposes under any or all of IRC Secs. 2036(a), 2038(a)(1) and 2035. Note that the gift tax case was resolved by stipulation, subject to the court's conclusion on the estate tax issues involved.
The burden of proof issue, the estate not having argued for shifting of the burden of proof under IRC Sec. 7491(a), was found not to be relevant to the court's determination of the issues, i.e. such depended on the facts and overall record before the court, including which party satisfied the burden of persuasion.
So the court identified, first as to the transfer of assets (funding) to MFV and second as to the gift transfers of MFV interests, how it would analyze the issues, including, on the funding of the LLC, whether the "bona fide sale" exception to Sections 2036 and 2038 would apply to the estate's benefit.
With respect to the gifts, the court determined that those transfers of MFV interests were not subject to the referenced exception, and so the question of issues such as the "express or implied agreement" provision of 2036(a)(1), were considered by the court.
Section 2035, gross estate inclusion of certain transfers within 3 years of death, was found not to apply, since the court determined that neither 2036 nor 2038 applied to the situation – a reminder that generally outright gifts of property (without retained interest issues) are exempt from the 3-year rule(except if the transfers are of life insurance).
1. Section 2036(a).
The Tax Court considered first the transfers of assets by decedent to the LLC, and separately the gift transfers by decedent to her daughters' trusts. These were deemed separate transactions, even though the overall intention of forming MFV was to fund it and then that the sole member, the decedent, would make gifts of interests therein. Note how in the Rector case, Judge Laro considered the funding and gifting plan to be integrated, and thus refused to separate the two "steps".
As to the funding transfers of the LLC, here the court determined that the bona fide sale exception to 2036(a) applied, thus making 2036(a) not an issue requiring analysis of (a)(1) and (a)(2). Citing the Goetchius decision, the court found under the Mirowski facts that the transferor "received benefit in full consideration in a genuine arms-length transaction."
The legitimate and significant non-tax reasons for creating the entity were identified, the court stating, at page 50 of its opinion, that these reasons were as follows:
1. joint management of the family's assets by her daughters and eventually her grandchildren,
2. maintenance of the bulk of the family's assets in a single pool of assets in order to allow for investment opportunities that would not be available if Ms. Mirowski were to make a separate gift of a portion of her assets to each of her daughters or to each of her daughters' trusts, and
3. providing for each of her daughters and eventually each of her grandchildren on an equal basis.
The other advanced reason for MFV, namely, to increase asset protection, was found not to be significant in this case.
Note that in response to IRS's claim that facilitation of lifetime giving can never be a significant nontax reason to form and fund an FLP or LLC(citing Bongard v. Commissioner), Judge Chiechi rejected this assertion. She stated that in Bongard, the court had found only that gift giving was not a significant factor.
Each of the IRS's several contentions was in turned identified, discussed and rejected by the Tax Court here, including the statement that the several cases cited as relevant by the IRS were all distinguishable on their facts from the instant case. See footnote 47 for the cases cited by the Service, including, Korby, Thompson, Rosen, Strangi, Harper and Harrison. So what we know is true- each case must be determined on its own facts.
Thus, just as in the Stone cases, here in Mirowski the facts being excellent for the taxpayer estate saved the day at trial. Obviously, estate counsel did an excellent job in developing the record and in providing credible evidence, including, as acknowledged by Judge Chiechi: "…we found Ginat Mirowski and Ariella Rosengard (two of the three daughters of decedent) to be completely candid, sincere, and credible and accorded controlling weight to their respective testimonies."(fn. 42).
Decedent retained outside MFV significant assets, totaling $7.5 million in overall value, of which over $3 million was in liquid form. The court found that there was no express or implied agreement that any LLC distributions would be made to allow decedent to pay gift tax on the gifts of MFV interests. Decedent had substantial liquid assets in her name, the LLC was mandated to make annual distributions of net cash flow, and decedent could have borrowed as needed to pay the gift tax due.
Further, the court determined that at all relevant times upon its formation(including after decedent's death), MFV was a "valid fundtioning investment operation and has been managing the business matters relating to the ICD patents and …license agreements, including related litigation."(page 54) And at page 55 of the opinion, Judge Chiechi rejected "…the suggestion in IRS's contention (2) that the activities of MFV had to rise to the level of a ‘business' under the Federal income tax laws in order for the exception under section 2036(a)…to apply."
The unexpected and rapid deterioration in decedent's health which led to her death was determined not to be a negative factor relating to recognition of the LLC.
The IRS tried to convince the court that the entity formation and gift plan was one integrated transaction, and thus that decedent, in effect, only received a 52% interest in MFV – a sort of "gift on formation" argument. This was readily rejected by the Tax Court.
Then the court turned to the gifts by decedent of a 16% MFV interest to each of the three daughters' trusts. Here, of course, as the court stated, there was not available a bona fide sale exception. So the court took on the issues involved in both IRC Sec. 2036(a)(1) and 2036(a)(2), determining neither provision of 2036(a) applied to treat the gifts as testamentary transfers.
First, no express retained income or enjoyment retention under 2036(a)(1) was found by the Tax Court. The IRS contended that since decedent was the managing member (General Manager) of MFV, her authority "included the authority to decide the timing and amounts of distributions from MFV."
Not so, said the court, pointing to the operating agreement and State law limitations on such General Manager authority. As to the operating agreement, the provisions regarding annual mandated distributions, the required distributions of capital asset disposition proceeds (including in liquidation, etc.) were significant limitations on the General Manager's authority, couple with general fiduciary duties.
An excellent discussion of the LLC's operating agreement and its impact on the situation of a decedent/donor manager is set forth in the opinion, implicitly rejecting the argument to the contrary made by Judge Laro in the Rector case.
As to an implied agreement or understanding of retained income or enjoyment under 2036(a)(1), as argued by the IRS, the court determined this contention had been considered and answered in dealing with the bona fide sale exception issue.
But the Service claimed it was of "particular significance" here that about a year after decedent's death, a non-pro rata distribution of over $36 million was made by MFV to decedent's estate to pay the 2001 gift tax and the estate tax, among other things. As to whether such is proof of an implied agreement before death, the court concluded in the negative, pointing to the lack of any expectation of decedent's sudden death.
Note that the estate tax, arising only as result of decedent's death, could not have been her personal obligation. See footnotes 49 and 66.
Then at page 75 of the court's opinion, the 2036(a)(2) issue was considered, and its application to his case was rejected by the court (without a great deal of discussion, but apparently generally based on the operating agreement restrictions.)
2. Section 2038(a)(1).
Property transfers were involved, and, given the bona fide sale exception (discussed above as to 2036(a)) also being available under 2038(a)(1), and so the court found that exception available here. Thus, the court did not need to address whether at the time of decedent's death, the enjoyment of property transferred during lifetime was subject to any alteration due to exercise of a power of decedent alone, or in conjunction with any other person.
This case brings to mind the excellent facts involved in an earlier taxpayer victory in Tax Court, cited in the Mirowski opinion, namely, Estate of Stone v. Commissioner, in which the bona fide sale exception to Secs. 2036(a) also was found applicable on excellent facts clearly presented to the court.
Perhaps the good facts present in Mirowski, as in Stone, are hard to "duplicate" or develop in many FLP/LLC cases. However, this opinion is must reading for practitioners who, first of all, wish to develop plans with the optimal opportunity for success against IRS attach.
In addition, it should be said that even a taxpayer victory situation, such as here, can be used as an educational tool with clients – and perhaps to justify the significant fees necessary in proper pass-through entity planning!
As has been evident in recent years, the bona fide sale exception is the first line of defense. However, attention still must be given to the "express or implied agreement or understanding" issue of 2036(a)(1). The real and significant non-tax purposes for the entity (not required, for e.g., in the case of merely gifting real estate co-tenancy interests) must be a major emphasis on the part of planners if the high bar for transfer tax recognition of such entities is to be cleared.
HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!
LISI Estate Planning Newsletter # 1268 (March 31, 2008) at http://www.leimbergservices.com/ Copyright 2008 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited – Without Express Permission.
Estate of Anna Mirowski v. Commissioner, T.C. Memo. 2008-74(3/26/08); Estates of Stone v. Commissioner, T.C. Memo. 2003-309; Estate of Rector v. Commissioner, T.C. Memo. 2007-367(see LISI Estate Planning Newsletters #s 1220 and 1221); Bigelow v. Commissioner, 503 F.3d 955(9th Cir. 2007(, affirming T.C. Memo. 2005-65(see LISI Estate Planning Newsletter #1187); Goetchius v. Commissioner, 17 TC 495(1951); Estate of Bongard v. Commissioner, 124 TC 95(2005); and the IRS's cited cases(rejected as relevant by Tax Court), namely, Estate of Korby v. Commissioner, 471 F.3d 848(8th Cir. 2006), affirming T.C. Memo. 2005-103, Estate of Thompson v. Commissioner, 382 F.3d 367(3d Cir. 2004), affg T.C. Memo. 2002-246, Estate of Rosen v. Commissioner, T.C. Memo. 2006-115, Estate of Strangi v. Commissioner, T.C. Memo. 2003-145, affd. On one ground only, 417 F.3d 468(5th Cir. 2005), Estate of Harper v. Commissioner, T.C. Memo. 2002-121, and Estate of Harrison v. Commissioner, T.C. Memo. 1987-8.
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