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Click here for the full text of this decision FACTS:In 1991, Ruth Kimbell created a revocable living trust that she and her son, David Kimbell, administered as co-trustees. In 1998, Ruth, David and David’s wife created a limited liability company. Ruth contributed $20,000 and received a 50 percent interest. David and his wife contributed $10,000 each, for 25 percent interests each. David was the LLC’s sole manager. A few months later, with assets from the trust and the LLC, the Kimbells created a limited partnership. The trust contributed approximately $2.5 million in cash, oil and case working interests, oil and gas royalty interests, securities and other assets for a 99 percent pro-rata limited partner interest. The LLC contributed approximately $25,000 for a 1 percent pro-rata interest. Thus, through her contributions to the partnership through the trust and the LLC, Ruth owned 99.5 percent of the partnership. She retained more than $450,000, however, outside the entities for her personal expenses. The partnership agreement stated several primary purposes of the agreement, including growing family wealth, providing flexibility and continuity in business planning for the family and to preserve family harmony and avoid litigation expenses. The LLC, as general partner, managed the partnership and had exclusive authority to make distributions. The trust, as limited partner, had no right to withdraw from the partnership or to receive a return until the partnership was terminated. The partnership agreement specifically stated that the general partner (the LLC, managed by David) owed only a duty of loyalty and care to the partnership. The agreement also stipulated to the percentage of interests necessary to elect a new general partner. Ruth died in March 1998. Her estate filed federal estate tax returns in December of that year, when the partnership was valued at approximately $2.4 million. The estate claimed that because Ruth lacked control over the LLC and the LLC’s interest in the partnership, her estate was entitled to a 49 percent discount. The IRS, however, audited the estate and said that the value in the assets transferred to the partnership, rather than Ruth’s interests in those entities, should have been included in the gross estate under Internal Revenue Code �2036(a). Section 2036(a) states as a general rule that the value of the gross estate shall include the value of all property to the extent of any interest of which the decedent has at any time made a transfer where she retains the possession, enjoyment or right to income from. The section includes an exception for cases of bona fide sales for adequate and full consideration. The estate paid the IRS tax bill, then filed for a refund. On cross-motions for summary judgment, the district court found that the government had demonstrated as a matter of law that Ruth’s transfer of assets to the partnership and the LLC were subject to �2036(a). HOLDING:Vacated and remanded. The court explains that �2036(a) recognizes that some assets transferred prior to death must be recaptured into the estate so as to prevent the circumvention of federal estate tax by using transactions that do not bypass the transferor’s enjoyment of the transferred property. There are two exceptions that will allow a transfer to escape �2036(a)’s reach, the court continues. First, when the transfer is a bona fide sale for full and adequate consideration. Second, when the decedent did not retain either the possession, enjoyment or rights to the transferred property, or the right to designate who will possess or enjoy the transferred property. The court rejects the trial court’s finding that the transfer was not bona fide by definition because it was made between family members. The district court found that the transfer to the partnership for a pro rata share was really just a recycling of value prohibited by Estate of Harper v. Comm’r, 83 T.C.M. 1641 (T.C. 2002), which ruled that a bona fide sale had to be both an arm’s length transaction, and be for adequate and full consideration. The Harper court said transactions between family members are not at arm’s length. The court, however, finds that Wheeler v. United States, 116 F.3d 749 (5th Cir. 1997), stands for the proposition that determining whether a transaction was bona fide and made for adequate and full consideration is an objective inquiry, not a per se rule. Wheeler further makes clear that in this circuit, a taxpayer’s testamentary or tax-saving motivation does not by itself trigger recapture under �2036(a). “In summary, the Wheeler case directs us to examine whether ‘the sale . . . was, in fact a bona fide sale or was instead a disguised gift or a sham transaction.’ “ The court examines several Tax Court cases where a transfer qualified as a bona fide sale and determines that what is required is a situation where the decedent/transferor actually parted with her interest in the assets transferred, and the partnership/transferee actually parted with the partnership interest issued in exchange. “In order for the sale to be for adequate and full consideration, the exchange of assets for partnership interests must be roughly equivalent so the transfer does not deplete the estate. In addition, when the transaction is between family members, it is subject to heightened scrutiny to insure that the sale is not a sham transaction or disguised gift. The scrutiny is limited to the examination of objective facts that would confirm or deny the taxpayer’s assertion that the transaction is bona fide or genuine.” In further reviewing the district court’s notion that Ruth’s contribution of more than 99 percent of the assets into a partnership to be managed by her son was nothing more than a recycling of value, the court takes note of the government’s additional argument that it is inconsistent on the one hand for the estate to assert that the value of Ruth’s interest in the partnership is worth only 50 percent of the assets she transferred (as discounted for lack of control and marketability), and on the other hand claim that the partnership interest Ruth received in exchange for the assets transferred was adequate and full consideration for the transfer. The court says the government’s argument is a case of comparing apples to oranges because it conflates the willing buyer-willing seller test of fair market value with the proper test for adequate and full consideration under �2036(a). There is nothing inconsistent in acknowledging both that the investor’s dollars have acquired a limited partnership interest at arm’s length for adequate and full consideration, and, that the asset has a present fair market value. There are financial considerations other than the purchaser’s ability to turn around and sell the newly acquired limited partnership interest for 100 cents on the dollar. “The proper focus therefore on whether a transfer to a partnership is for adequate and full consideration is: (1) whether the interests credited to each of the partners was proportionate to the fair market value of the assets each partner contributed to the partnership, (2) whether the assets contributed by each partner to the partnership were properly credited to the respective capital accounts of the partners, and (3) whether on termination or dissolution of the partnership the partners were entitled to distributions from the partnership in amounts equal to their respective capital accounts.” The court concludes that the answer to all three questions is “yes.” The court takes note of the evidence given to support the estate’s position that the transaction was made for substantial business and other non-tax reasons, such as Ruth’s retention of nearly a half-million dollars in assets outside the partnership; assets were formally assigned to the partnership; oil and gas working interests (which require active management) were contributed; and certain liability issues. Having concluded the evidence supports the finding of a bona fide sale, the court goes on to address whether the other exception to �2036(a) applies. That is, whether Ruth retained a right of enjoyment of the transferred property. The court rules that even if the transfer did not constitute a bona fide sale for full and adequate consideration, Ruth did not retain sufficient control of the assets transferred to the LLC to make her transfer subject to �2036(a). OPINION:Davis, J.; Davis, Barksdale and Prado, JJ.

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