Six mistakes muddy court case: A lesson in estate planning
Many tax cases are studied because they are informative about court-approved actions that resulted in some tax-saving objective.
And a few cases are instructive in what not to do.
The case of T. Hurford Estate is one of the latter. (Estate of Thelma G. Hurford v. Commissioner, TC Memo 2008-278, Dec. 11, 2008.)
The sad saga begins in 1999 with the death of Gary Hurford. In planning his estate, Hurford opted for a simple two-trust approach in his will, rather than the family limited partnership (FLP) structure recommended by his estate attorney.
When Hurford died, $675,000 was placed in a family trust for the benefit of his wife and children, and the remainder of his $14 million estate was placed in a marital trust. Gary's wife was the executor of the estate and the trustee of both trusts.
Shortly after Hurford's death, his wife and their three children became disillusioned with the estate planning attorney and replaced him with someone more "personable." The new attorney laid out a strategy to reduce the estate taxes expected at Mrs. Hurford's death by combining a FLP strategy with a private annuity.
Under the plan, Mrs. Hurford transferred cash, stock, phantom stock units and real estate from herself and from the two trusts created under her husband's will to three FLPs.
Mrs. Hurford's transfer of the family trust assets to the FLP might be considered the first mistake.
The family trust was established to capture Mr. Hurford's unified credit. His wife's beneficial interest in the family trust was limited by an ascertainable standard to prevent the assets in that trust from being included in her estate. By transferring the trust assets to the FLP, the court ruled that Mrs. Hurford had taken control of those assets, causing them to become part of her estate.
After the FLPs had been formed, but before the first transfers of property to the FLPs, Mrs. Hurford sold interests in the FLPs to two of her children in exchange for a private annuity.
Mrs. Hurford died in 2001. On audit of her estate tax return, the IRS asserted an estate tax deficiency of $9.8 million.
The court agreed with the IRS that Mrs. Hurford's transfer of property in exchange for interests in the FLP were not bona fide sales for adequate and full consideration.
The court concluded that the nontax reasons for the transfer offered during the trial were not a legitimate and significant motivation.
The court also found that the value of Mrs. Hurford's interest in each FLP was worth far less than the value of the assets that she contributed. No appraisal of the assets was obtained when the transfer occurred. This was the second mistake.
Rather than obtaining an appraisal, the attorney recorded the assets at the values used on Mr. Hurford's estate tax return. More than a year had passed since Mr. Hurford's death.
Shortly after the transfer of assets to the FLPs, Mrs. Hurford, needing to make an estimated tax payment, withdrew funds from one of the FLPs – the third mistake.
The court took this withdrawal as an indication that Mrs. Hurford did not retain sufficient assets outside of the FLP.
The court further found that the private annuity agreement was not a bona fide sale but a "disguised gift or sham transaction."
Again, no appraisal was obtained of the FLP interests – the fourth mistake – and the annuity payments were based on a calculation that used a discount from the values of the assets in Mr. Hurford's estate.
Because Mrs. Hurford's children did not have sufficient assets or income, independent of the FLPs, to make the annuity payments, each month they returned some of the assets they had just "purchased" with the private annuity to their mother.
This was the fifth mistake, because it indicated to the court that Mrs. Hurford had not actually parted with the assets.
Finally, the sixth mistake was that, although one of the children was not a party to the private annuity, it was clear to the court that the other two children fully intended to make sure that he received one-third of the assets at their mother's death.
This fact indicated to the court that Mrs. Hurford had retained control over the disposition of her assets until her death.
As a result, the court included in Mrs. Hurford's estate all of the assets from her husband's estate and all of the assets she attempted to transfer to her children through the creation of the FLPs and the private annuity.
So, did the parties in this case do anything right?
The family retained an attorney who, in the words of the court, "left many of the i's undotted and t's uncrossed." They also retained an accounting firm to prepare income tax returns, but the returns did not always reflect the transactions that occurred.
The court concluded that the family relied on competent professionals who had sufficient expertise to justify reliance.
It also determined that the family provided necessary and accurate information to their advisers, and they relied in good faith on the advisers' judgment. Therefore the court refused to uphold a $2 million negligence penalty.
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