Originally published on forbes.com.

Estate of Lois L. Lockett, et al. v. Commissioner, TC Memo 2012-123

One of the most fundamental principles of partnerships is that to have a partnership, you need partners.  That is plural.  So if someobody is getting 100% of everything, there may be a problem.  That is what the Lockett family found when it was denied any valuation discounts on the assets in the Mariposa partnership included in the Estate of Lois Lockett.

Sometimes I think the hardest thing about family limited partnerships is that they involve families.  That probably accounts for some of the difficulties in getting the Lockett family's partnership called Mariposa going.  Here is some of the story.  Lois Lockett, a widow, had two sons, four grandchildren, a step grandchild, two daughters-in-law and an ex-daughter-in-law.  Guess who the moving force was in getting the estate plan moving ?

Mary, Mrs. Lockett's ex-daughter-in-law, was a financial planner who had advised Mrs. Lockett and assisted with her financial affairs for a number of years. David Haga who had represented Mrs. Lockett from 1996, was her estate planning attorney, and Gerald Bernard was her accountant. On February 11, 2000, Mrs. Lockett created a revocable trust, the Lois L. Lockett Trust (Lockett Trust). The Lockett Trust document named Mrs. Lockett and Mary as cotrustees. Mary and Mr. Haga also recommended that Mrs. Lockett create a family limited partnership. The Lockett family being close, Mrs. Lockett decided to involve Joseph, Robert, and Mary in the creation of the partnership. With so many people involved, a good amount of indecision arose which stalled the orderly creation of the partnership.

Joseph and Robert thought it would be a good idea to hire their own lawyer.  Bring in another lawyer.  That is sure to speed things up.  It may have brought things to a head anyway.

On October 12, 2001, Mary wrote a letter signed by herself and Mrs. Lockett to Mr. Haga in reference to their September meeting. In the letter Mary expressed reservations about having Mr. Miller involved in the drafting of the partnership agreement, essentially requesting that his changes be ignored. Mary also recommended that she be named a general partner so that she could protect Mrs. Lockett's limited partnership interest. Mary recommended a number of other changes and stated that once those changes were made she would encourage Mrs. Lockett to sign the partnership agreement.

Joseph and Robert had always deferred to Mary's judgment when it came to their mother's finances. Mary had been the driving force behind the creation of Mrs. Lockett's estate plan and the formation of Mariposa. However, Joseph and Robert became suspicious of Mary's motives. They moved their mother to a new assisted living facility so that she would be farther away from Mary and closer to them. In January 2002 Joseph and Robert decided to exclude Mary from further involvement in Mrs. Lockett's financial affairs. On March 2, 2002, Mrs. Lockett executed a durable power of attorney removing Mary as her attorney-in-fact and appointing Joseph and Robert in her stead. On that same date, Mrs. Lockett executed a first amendment to the terms of the Lockett Trust removing Mary as cotrustee and appointing Joseph and Robert to serve as cotrustees.

There was still a lot of indecision, though.

The Mariposa agreement named Joseph and Robert as general partners and Mrs. Lockett, Joseph, Robert, and Trust A as limited partners. Even without Mary's involvement the indecision continued. At the time the Mariposa agreement was signed, Mrs. Lockett, Robert, and Joseph had still not agreed upon initial capital contributions or their percentage interests in Mariposa.

Ultimately Robert and Joseph would never make any contribution for their general partnership interests.  They subsequently tried to argue that there was an implicit gift to them of a 1% interest, that they provided services and later on that a contribution that Mrs. Lockett made in the amount of $125,000 was actually made on their behalf giving them an 11.68% interest.

When Mrs. Lockett died her interest in the partnership, which was listed as 100%, was valued at $667,000. The underlying assets were stipulated in the case as being worth $1,106,841.  There were discounts for lack of control and marketability.  The IRS tried to argue that there never was a partnership at all because there was no business conducted.  The Court did not buy that argument:

We agree there was minimal economic activity, but we find no requirement that an Arizona business engage in a certain level of activity. Moreover, we find that Mariposa was operated to derive a profit. Mariposa hired Mr. Russell to manage its portfolio of stocks, purchased real estate which it leased, and made loans requiring annual interest payments. Accordingly, we find that Mariposa operated a business for profit.

There was a problem, though, which turned out to be insurmountable.  I find the use of the passive voice here interesting - In May 2003 a decision was made to terminate Trust A. The dissoution of Trust A which involved the transfer of its interest in Mariposa to Mrs. Lockett is what made her a "100% partner".  What were they thinking ?  They must not have been thinking that they terminated the partnership, but that is what the IRS and, more importantly, the Tax Court ended up thinking:

Article 9.1 of the Mariposa agreement provided Mariposa would be dissolved upon the acquisition by a partner of all the interests of the other partners. Therefore, Mrs. Lockett's acquisition of Trust A's limited partnership interest caused the dissolution of Mariposa under Arizona law. On December 31, 2002, Mrs. Lockett became the legal owner of all of Mariposa's assets pursuant to Arizona law.

The case also got into several loans that Mrs. Lockett made to her heirs.  Even though no payments were made on them, the ones that were supported by promissory notes were treated as loans rather than gifts.  I would have recommended that Robert and Joseph fund their general partner contributions from a source other than the loans, but it would certainly have been better if they had done that rather than not funding them at all.  Alternatively a well documented gift to them of a small interest in Mariposa might have done the trick.  Finally you have to wonder about the decision that was made to terminate Trust A.  I hope it accomplished some greater purpose than saving on filing one return.

You can follow me on twitter @peterreillycpa.

Timber Case Shows Value of Family Limited Partnership

Originally Published on forbes.com on July 7th,2011

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Estate of Natale B. Giustina, et al. v. Commissioner, TC Memo 2011-141 

 There are many good business reasons to consider putting assets into a family limited partnership.  I can and have discussed them in sober detail, but I will gloss over that for now and skip to what gets people excited.  Valuation discounts.  Natale B. Giustina owned 41.128 % of Giustina Land and Timber Company Limited Partnership (GLT).  The value of that interest was the subject of the case. In cases like, this there will be multiple appraisals with the appraisers disagreeing on various points.  The Court will usually agree with one appraiser on one thing, another on something else and sometimes make something up on its own.  In this case, there was one item on which there was no disagreement.  The gross value of the partnership’s assets (mostly vast tracts of timber land-some 48,000 acres) was approximately $150,000,000.  In arriving at the $150,000,000 the timber lands value of $143,000,000 was net of a 40% discount to reflect the delay in selling the land.)  So if the case was being decided by the simple minded jurors in the Levy case, the value of the interest would be $60,000,000 and change. (Unless the land were actually sold by the time of the trial which would make the partnership interest value higher).

  The Tax Court instead considered the value on the Form 706 based on an appraisal by Columbia Financial Advisors -  $12,678,117.  The estate brought in another appraiser named Robert Reilly (no relation, that I know of, although I do have a brother by that name) who arrived at $12,995,000.  Then there was John Thomson, the IRS expert, who came in at $33,515,000.  The Tax Court, not exactly splitting the difference in this case ended up at $27,454,115 (Or as the Court modestly refers to it “the correct value”).  The as filed value was less than 50% of the “correct value”, but the Court did not allow the IRS to assess a penalty.

How can this be ?  If prior to his death Mr. Giustina had received a distribution of 19,000 or so acres that were representative of the whole and he had held those acres on the date of his death, they would have been worth at least $60,000,000.  Inside a partnership in which he was the largest partner and all seven of the other limited partners had names like Syliva B Giustina and Natalie Giustina Newlove even the IRS is only looking for about 50% and an appraisal at around 20% doesn’t rate a penalty.

Since Mr. Giustina could not force a sale of the assets, the primary valuation of the partnership was based on the discounted present value of the cash flow.  The Court thought Mr. Reilly had done the better job on estimating the cash flow:

 First, as Reilly explained on pages 17-18 of his rebuttal report, there was an internal inconsistency between Thomson’s cashflowestimates and his calculation of the effect of lack of control on the value of the 41.128-percent limited partner interest. The inconsistency led Thomson to overvalue it. Second, Thomson unrealistically assumed that the partnership’s operating expenses would remain fixed, even though he projected that its revenues would increase 3 percent annually. Third, Thomson’s estimate of annual cashflowswas extrapolated from the actual cashflow results of the most recent year. By contrast, Reilly extrapolated from the cashflow results of five consecutive years. Reilly’s use of five years of data is sounder because it reduces the effect of a temporary variation in cashflow.

The Court was not totally satisfied with Mr. Reilly’s valuation based on cash flow.  He had deducted 25% for income taxes, which was inappropriate since he had used a pre-tax rate of return to discount the cash flows.  In addition they quibbled with his discount rate. The rate was built up from four components.  A risk free rate of 4.5%, a beta adjusted risk premium of 3.6% (about half that of the S&P 500), a small stock equity risk premium of 6.4% and an additional risk premium of 3.5% because the timber was concentrated in Oregon.  He then reduced the rate by 4% for assumed growth.  The Court cut the 3.5% to 1.75%, because some of that was based on “unique risk”.   According to the Court the market does not pay for unique risk, since it can be avoided by diversification.

The Court rejected the use of the guideline company method.  The proposed companies Plum Creek Timber Co., Inc., Pope Resources LP, Deltic Timber Corp., and Potlatch Corp, were not comparable enough. Both Deltic and Potlatch have substantial operations other than owning timber land and selling timber.

In the end the Court used the discounted cash flow value prepared by Mr. Reilly, as adjusted, and a liquidation value.  It gave the discounted cash flow method a 75% weight, its prediciton on the probability that the company would continue to operate.  There was no discount for lack of control allowed, since that is reflected in the weight given to the partnership conitnuing to operate rather than liquidate.  There was a discount for lack of marketability of 25% but that was only applied to the operating value not the liquidating value.

There is something about all this that disturbs me intellectually.  The parties seem to agree that if you wanted to buy all the stuff in the Giustina partnership it would cost you $250,000,000 (remember the 40% discount on the land value).  On the other hand a valuation of a 40% interest in all that at less than $13,000,000 was reasonable, although low, the ”correct value” being $27,454,115. There has to be something bizarrely wrong about our capital markets for this to make any sense.  Fortunately, thinking about matters like that is not my job, man.  My motto in tax matters is “It is what is.  Deal with it.”  There are a host of execution issues and numerous ways to screw up family limited partnerships as I have written elsewhere, but the family limited partnership is once again proven to be a very valuable estate planning tool.

IRS Disses Doggie Diplomas and Other Developments

Originally published on Passive Activities and Other Oxymorons on June 22nd, 2011.
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FISHER v. U.S., Cite as 107 AFTR 2d 2011-XXXX, 04/19/2011

There has already been a partial decision in this case which I mentioned in a previous post.  The government got summary judgement on whether a restrictions on transferability discount would apply to a single asset family limited partnership.  Apparently that was not the end of the story. After all there are still discounts for lack of marketability (even if they let you sell the damn thing nobody would want to buy it anyway) and minority interest.  This particular decision, which is also not the end of the story is about evidence.  The taxpayers want to bring into evidence what the IRS was originally willing to allow.  The IRS doesn't think that relevant.

The present Motion in Limine seeks to preclude Plaintiff from introducing evidence of the minority interest and lack of marketability discounts used by the IRS in arriving at the February 13, 2006 assessments. See generally dkt. no. 101. The United States contends that because this case involves a de novo review of the fair market value of the property at issue, the calculations of the IRS at the administrative stage are irrelevant. Id. at 4. Plaintiff contends that evidence should be allowed in rebuttal if Mark Mitchell, CPA (“Mitchell”), the United States' expert, testifies that the minority discount should be seven percent rather than the nineteen percent purportedly used by the IRS in the February 13, 2006 assessment. Dkt. No. 105 at 3.


In this case, introduction of evidence of the minority interest discount used by the IRS in the February 13, 2006 assessment is irrelevant. The issue is what the correct minority interest discount is, not what it was previously determined to be. Accord. Janis, 428 U.S. at 440; see also R.E. Dietz Corp. v. United States, 939 F.2d 1, 4 [68 AFTR 2d 91-5238] (2d Cir. 1991) (“The factual and legal analysis employed by the Commissioner is of no consequence to the district court.”). The previously used minority interest discount has no baring on factfinder's de novo determination of the property's fair market value. Because evidence of the previously used minority interest discount is irrelevant, it must be excluded.

This reminds me a little of the Levy case.  They were starting with a 30% discount and took it to a jury which allowed them 0%. (It was also a refund case so being stuck with the 30% was actually as bad as it could get.) In that case the taxpayers were trying to keep out the amount the family actually ultimately received.

Private Letter Ruling 201117036

This was an organization formed to provide credit counselling services that was denied exempt status.

Based on the information you provided in your application and supporting documentation, you are not operated for exempt purposes under section 501(c)(3) of the Code. An organization cannot be recognized as exempt under section 501(c)(3) unless it shows that it is both organized and operated exclusively for charitable, educational, or other exempt purpose. You failed to meet the operational test of section 1.501(c)(3)-1(a)(1) and section 1.501(c)(3)-1(c)(1) of the Regulations because you are organized for substantial private and commercial purposes, and operate in the same manner as a private commercial entity.


To qualify under IRC section 501(c)(3), an organization cannot have a non-exempt purpose that is more than insubstantial. Your primary activity is the provision of pre-bankruptcy certification and post-bankruptcy counseling for fees. You devote most of your time and activities to selling bankruptcy certifications to the general public under the guise of financial counseling. You have not shown that you are operated exclusively to educate individuals for the purpose of improving or developing their capabilities. Rather, the fact that no educational materials will be provided unless the client registers for a counseling session is an indication of operation for a primarily business purpose. Your primary focus is to expand your client base and to issue bankruptcy certificates as quickly as possible in order to generate revenue. Analogous to the organization described in Better Business Bureau of Washington D.C., Inc. v. United States supra, your activities appear to have an underlying commercial motive that distinguishes your educational activities from that carried out by a university or educational institution.

If you want to be recognized as a charity maybe you could kind of like do something charitable.

Private Letter Ruling 201117035

Here the IRS shows its narrow speciesism.  Among the possible purposes that qualify for exemption is "education".  It turns out, though, that it has to be human beings who are being educated.  Doggy University (the name I made up for the anonymous ORG in this ruling) does not qualify.

ORG holds dog obedience training classes, and awards the dogs a degree after completion of the course and also award, them prizes at the shows events. While the owners received some instruction as to the training of the dogs, it is the dog that is primary object of the training.




The nature of obedience training requires that the owner of the dog appear at the classes so that the dog is trained to respond to his owner's commands. While the owner receives some instruction in how to give commands to his dog, it is the dog that is the primary object of the training. The dog is also the primary object of the subsequent training in sporting and show events. Therefore, the organization's training program for dogs is not within the meaning of educational as defined in the regulations.


Dog training in the manner you describe is not exempt purposes as described in IRC section 501(c)(3), because the organization's training program for dogs as well as its dog shows is not within the meaning of educational as defined in the regulations . In fact, you primarily serve the private interests of the dog owners and thus not operated exclusively for 501(c)(3) purposes.


Private Letter Ruling 201117011

Taxpayer was granted 120-day extension from date this letter was issued, to make election under Code Sec. 469(c)(7)(A); to treat all of his interests in rental real estate as single rental real estate activity effective stated year.


Rental activities are "per se" passive.  There is an exception for people in real estate trades or businesses if they meet certain requirements.  They still have to materially participate in the properties.  Absent the election to aggregate the material participation standard can be challenging when there are multiple properties.  Taxpayers who have failed to make the election can sometimes get relief with a late election as the taxpayer in this ruling did.

Serial Guest Blogger Comments on Family Limited Partnership Case

Originally published on Passive Activities and Other Oxymorons on May 17th, 2011.
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Matt Erskine was my first guest blogger.  Now he is back with commentary on an important family limited partnership case.


Another Attack on FLPs: Jorgensen v. Comm’r. 107 AFTR 2011


Erskine Comment: The 9th Circuit Court of Appeals has taken another swipe at the use of Family Limited Partnerships for transferring stock between generations. In this case, the deceased, Erma V. Jorgensen, transferred stock to two Family Limited Partnerships. The Court affirmed the decision of the Tax Court which sided with the IRS position that the entire value of the stock in the FLP should be included in her estate and denied the use of the discounted value, as the Estate alleged.

The Appeals Court affirmed the Tax Court’s using the post-transfer operations of the FLP to determine that the deceased 1) retained some economic interest in the assets of the FLP and 2) the transfer to the FLP by the deceased was not a bona fide sale for good and adequate consideration.

The retained economic interest was based on the decedent writing $90,000 worth of checks from the partnership for her personal expenses (even though there was an attempt to correct this by her accountant when this “error” was discovered) and because $200,000 of her estate taxes where paid from the Partnership.

The bona fide sale defect was based on the facts that:

“The type of assets transferred (marketable securities) did not require significant or active management, there was some disregard of partnership formalities, and the nontax justifications are either weak or refuted by the record (including formation of a second family partnership to hold higher-basis assets for gift-giving purposes, purportedly for the same nontax justifications that the original partnership could have already served).”

This reinforces the high level of scrutiny that FLPs and FLLCs incur by the Courts and the Service and the requirement that not only the set up but the ongoing operations of the entities be done with exactitude to insure that the discounting is not disallowed.

Overall, I cannot see that FLPs should be relied upon now that they are under both legislative and court attack for any long term tax planning.

PAOO Comment - I'm not sure that I go all the way with Matt on rejecting FLP's as a valid tool.  For one thing they  frequently would be a good idea even if there were no discounts.  Jorgensen was definitely a case of poor execution.  In my post on the original case I mention the son's difficulty in "getting his head around" the idea that the partnership wasn't just like a bank account.  The most recent Jorgensen decision was in my backlog of draft posts.  I am planning on looking at it along with a couple of other cases.  Be sure to check out the Erskine and Company blog.

Sometimes You Need to Burn First

Originally published on Passive Activities and Other Oxymorons on March 7th, 2011.
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LINTON v. U.S., Cite as 107 AFTR 2d 2011-565, 01/21/2011

One of my earliest blog posts, mentioned the Lintons.  I was toting up the score on family limited partnerships for 2009 declaring the year to be a tie with two wins for the IRS and two for the taxpayers.  So early in the blogs existence I hadn't thought through all the implications of the scoring system.  So I will leave it to the readers to determine whether we need to reopen the score book for 2009.  The Lintons have appealed and appear to have won.  Perhaps it would be more accurate to say they have gotten the game into overtime.  In the first decision, the IRS won on "summary judgement".  The appeals court is sending the case back for reconsideration.

 You may have seen the cartoon on which the bumper sticker is based.  Ferocious barbarians are running around the village with torches while the chieftain reflects that it is better to pillage first.  That would seem to be a universal principle, but there are exceptions.

As I mentioned in a previous post, there are some excellent business and family reasons for establishing family limited partnerships.  The excitement though is about the discounts.  You put the assets in the family limited partnerships.  The resulting value of the partnership interests is less than a proportional amount of the underlying assets.  You need to form the partnership and put the assets in it before you make any gifts.  If you give away an undivided interest in the assets and the donees contribute those undivided interests, it doesn't work.  You need to do the thing that reduces the value, then make the gift - Burn, then pillage.

The parties have assumed that in determining the character of the Lintons' gifts, the sequencing of two transactions is “critical,” Senda v. Comm'r, 433 F.3d 1044, 1046 [97 AFTR 2d 2006-419] (8th Cir. 2006), and we do so too, without deciding whether that is always so in cases of this ilk. The transactions at issue are: (1) the contribution of cash, securities, and real property to the limited liability company, and (2) the transfer of LLC interests to the Lintons' children's trusts. If done in that order (and with some lapse of time between the transactions), as the Lintons contend occurred here, the gifts would ordinarily be characterized as gifts of LLC interests, and the value of those LLC interests might be discountable for tax purposes. If, however, the contributions to the LLC occurred after the transfer of LLC interests to the children's trusts, the gifts would ordinarily be characterized as indirect gifts of the particular contributed assets and would not be discountable.

In the first go round the court had concluded that things were done in the wrong order.  The Lintons, however, insisted that they had done their burning before they pillaged.  The problem is that this stuff is all just paperwork.  The way you tell what order things were done in is by the dates on the paper.  Here were the relevant documents :
Quit Claim Deed: signed by William and conveying a parcel of his separate property real estate to WLFB. The parties agree the quit claim deed was effective on January 22.

Assignment of Assets: signed by William as assignor and by both William and Stacy as assignees on behalf of the LLC.

Letters: signed by William and authorizing the transfer of securities and cash to WLFB. The parties disagree as to when the transfers of securities and cash were effected.

At the same meeting with attorney Hack, William, Stacy, and William's brother James Linton, signed, but left undated, several other documents:

Trust Agreements (four total—one for each child): signed by William and Stacy as grantors and by James as trustee; forming and apparently funding irrevocable trusts for the children.

Gift Documents (eight total—one each from William or Stacy to each trust): signed by William or Stacy as assignor and by James as trustee, gifting 11.25 percentage interests in WLFB to each respective trust.

Even though the burning documents were signed at the same meeting as the pillaging documents, the pillaging documents were not meant to be immediately effective.  Then came the oops moment :

Two or three months later, attorney Hack assembled these key documents. For all undated documents, he filled in the missing date as January 22, 2003. In his deposition, Hack stated this insertion was erroneous, and that these documents should have been dated January 31, 2003. William agrees that January 31 was the correct date. This testimony is consistent with that of Caryl Thorp, an accountant with Moss Adams, LLP, who advised the Lintons on the ordering of the transactions.

Really what good is a lawyer's story with out a CPA to back him up ?

The case goes into a fairly interminable discussion of what constitutes a completed gift under the laws of the State of Washington.  Here is the introduction to that discussion:

Under Washington law, “the elements of a completed gift are (1) an intention of the donor to give; (2) a subject matter capable of delivery; (3) a delivery; and (4) acceptance by the donee.” In re Marriage of Zier, 147 P.3d 624, 628 (Wash. Ct. App. 2006). The transfer of the LLC interests occurred when all four elements of a completed gift first existed simultaneously. We must determine when that was. We discuss each element individually, but we defer discussion of the first element, intention to give, until the end, as here it is both the decisive element and the most difficult to determine.


You probably don't want more of that, trust me.

They also discussed an entertaining theory advanced by the Lintons.  The argument is that if the gift of the LLC interests happened before the transfer of the property, then the Lintons should have gotten credit for the property fair market value in their capital accounts.  Hence if the IRS is right instead of a 47% discount, there is no gift all.  The Court wasn't buying it.

The Lintons' “failed-gift” theory is clever; unfortunately for them, it is too clever. The membership ledger of the LLC shows that the capital accounts of the children's trusts were, in fact, increased, as does the LLC's informational return that its accountants prepared and filed with the IRS in March 2004. The Lintons contend that if we conclude the government is right about the timing of the transactions, these documents were prepared on a mistaken assumption (i.e., that the LLC interests were transferred after the assets, and, therefore, by virtue of the IRC § 704 capital account rules, included a pro rata transfer of the assets from the donors' capital accounts to the donees') and should be ignored. On their theory, the informational return and the ledger would only reflect what everyone believed to be the state of the capital accounts, not the actual state of the capital accounts.

 But tax law is concerned “with the realities of a situation and not with the formalities of title.”...... The membership ledger and the LLC's informational return together reflect the substantive reality of the situation: All parties involved regarded the trusts' capital accounts as having been enhanced. In other words, all concerned parties acted as if William and Stacy Linton had “so parted with dominion and control [over the assets] as to leave in [them] no power to change [their] disposition.”

In the end.  This is not the end.  We will be hearing more about this case.

Genuine issues of material fact exist as to the sequence of transactions by which the gifts were made. We remand this question for the district court to determine, following further proceedings, when the four elements of a gift under Washington state law were simultaneously present, and, in particular, to determine when the Lintons first objectively manifested their intent to make the gifts effective. We also reverse the district court's grant of summary judgment in favor of the government as to the application of the step transaction doctrine. Finally, we affirm the district court's order denying summary judgment to the Lintons, holding that they are not entitled to summary judgment on their failed-gift theory.


I think the moral to the story is that forming a family limited partnership, funding it and making a gift of the partnership interests is probably worth more than one trip to the lawyer's office.  Let the village burn for a month and then go back and pillage it.

Survey Says - No Discount For Family Limited Partnership

Originally published on Passive Activities and Other Oxyomorons on December 13, 2010

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LEVY v. U.S., Cite as 106 AFTR 2d 2010-7205, 12/01/2010

Sometime in the last millennium there was a TV situation comedy called Angie.  It was about the early days of a marriage between a fellow from a very wealthy Philadelphia family and a waitress from a family of more modest circumstances.  In one of the episodes the two families compete on the game show Family Feud.  Family Feud is a wonderfully egalitarian contest.  Unlike Jeopardy, which requires you to come up with the one correct answer (Expressed in the form of a question)  the questions in Family Feud are matters of opinion.  If you get one of the top five or ten answers (something like that) that were determined by a survey you get some points.  The more common the answer you come up with the more points it is worth.

I forget how the Angie episode worked out in its entirety, but at least early on the husband's wealthy family (including the butler of course) was getting creamed.  People in the survey did not have champagne and caviar for snacks or start the day by checking stock prices.  At one point the host goes up and explains to them that the survey answers come from average people not the ultra wealthy.  They don't get it.  The lawyers for the Estate of Meyer Levy might have learned something from watching that episode, but they were probably studying hard in law school or taking polo lessons, the better to meet wealthy clients, while I was squandering my time learning life's lessons by watching television.

The case was a family limited partnership case.  Family limited partnerships can be a good idea for a multitude of reasons.  They are particularly attractive to people, who not, yet, having come up with a way to take it with them, want to control it all till they draw their final breath without having it all included in their taxable estate.  There's also the asset protection and as they say on Seinfeld yada yada yada.  The thing that people get excited about, though, is the discounts.  That's what the IRS gets excited about too.  Take a bunch of stuff and put it into a family limited partnership.  Say its a million dollars worth of stuff.  Now give 10% of the partnership to your kid.  How much is the gift worth ?  $100,000 ?  Do you think I would pay $100,000 for it ?  Of course not..  As a limited partner I don't get to vote.  On top of that your kid doesn't even have the right to sell it to me.  You have to hire a valuation expert to value the limited partnership interest (I sometimes think the estate tax is, in reality, a white collar jobs program).  She'll tell you its worth something like $65,000, more or less, depending on well yada yada yada. The IRS doesn't like this and is constantly attacking it.

Until recently they focused on poor execution which I discussed at length in one of my early blog posts.  Assets aren't really transferred to the partnerships.  Personal bills are paid directly by the partnership.  Distributions are not made in proportion to partnership ownership.  Tax returns are not filed or not done correctly.  In a more recent case, Fisher, discounts were not allowed for a single asset partnership, because it lacked business characteristics.  There was no discussion of flawed execution.

No discount was allowed to the Estate of Meyer Levy for the sale of its Plano real estate that was in a partnership.  The estate appealed the verdict alleging error on the part of the trial court.

The Estate argues that the trial court erred when it allowed the admission of

 (1) evidence of the ongoing negotiations over the sale of the property, specifically the offers and proposals;
(2) evidence of the listing price of the property, and the ultimate sale price of the property;
 (3) valuation testimony by the Government's expert based on flawed methodology; and
(4) opinion testimony by a lay witness and hearsay testimony.

Wow.  In a valuation case they considered what people were offering for the property and what it actually sold for.  That's pretty outrageous.  You see the problem was it wasn't a judge that had to think about these things.  It was a jury.  Who ends up on a jury ?  I'm not sure exactly. I suspect that they have more in common with the people Family Feud surveys for its answers than the people I run into at tax conferences.


The Estate contends that the jury arbitrarily disregarded unequivocal, uncontradicted, and unimpeached testimony of an expert witness, bearing on technical questions of causation beyond the competence of lay people. The Government counters that the jury had the partnership agreement in evidence from which it could have determined that there was no lack of control or marketability.

The record contains ample evidence to support the jury's verdict valuing the property at $25 million. The Estate listed the property, and eventually sold the property, for $25 million. It was immediately resold for $26.5 million. Sophisticated developers with no stake in the current litigation engaged in ongoing negotiations for the property for prices in the $20–25 million range. The Estate's expert testified that the market in Plano remained relatively flat during the period between Levy's death and the sale of the property. Also Jordan testified regarding the value of the property. Any of these provides sufficient support for the jury's verdict on the property.

The jury verdict regarding the discount also finds support in the record. The partnership agreement itself would be sufficient evidence. The jury could have rationally found that no discounts for lack of control or marketability were merited because the Estate controlled the general partner interest, which had nearly unfettered control over the Partnership's assets. The trial court did not abuse its discretion when it denied the Estate's motion for new trial.

I'm not a lawyer and I don't even play one on TV.  I prepare and review tax returns and do tax planning.  I also represent people who are being audited by the IRS, but there I'm generally dealing with accountants.  If my clients end up in Tax Court and win I'll still think that I lost.  I am fairly certain though, that it was the choice of the estate's lawyers to bring this matter to a jury.  To have that privilege, they had to pay at least part of the tax in order to be able to sue for refund in district court.  They could have instead gone to Tax Court where they would have had people who dealt with "technical questions beyond the competence of lay people" all the time and frequently allow discounts.  Somehow though they thought they would do better with a jury.

Apparently though the government lawyers saw to it that the jury found out that the Estate got $25,000,000 and these simple minded people thought that might be indicative of whatever the estate had was worth.  I suppose there was some sort of trial strategy that would keep this information undisclosed.  In which case the jury would have had to weigh the government's yada, yada, yada against the Estate's yada, yada, yada.  There might have been some logic to that.  If I was playing Family Feud and the question was "Name a class of people that are very popular" I would venture neither multi-millionaires or IRS agents.  If the question was "Name a class of people that are despised"  I think I might score higher with "IRS agents".  I mean no disrespect to IRS agents, their unpopularity is inherent in their jobs.

In  a refund suit in district court either the government or the taxpayer can ask for a jury.  I haven't been able to figure out which it was.  I did find that the executor had been a potential candidate for mayor of Austin Texas and the late Mr. Levy had established a fairly well known charitable foundation.  So there may have been a feeling that there was a home town advantage.  There was also a sense in which the Estate was playing with the house's money if it was the one that gambled on a jury, as is noted in a footnote:

Although we have declined to set aside the jury's verdict of zero discount, we note that the actual discount applied in taxing the Estate was thirty percent. Given the valuation found by the jury, it would have had to find a discount of larger than thirty percent for the verdict to make a difference to the judgment in this case.


I don't know whether this case will have a chilling effect on family limited partnerships or not.  My cumulative sense is that you should only do them if you think they are a good idea anyway.  Oddly enough, that will make it more likely that you will succeed on the discount issue.  I think the key planning point to take away from the case is the Court's comment that it would have been reasonable to find a zero discount because of the Estate's general partnership interest.

Courts and Value Billing

Canal Corporation and Subsidiaries v. Commissioner, 135 T.C. No. 9
KELLER, ET AL. v. U.S., Cite as 106 AFTR 2d 2010-6343, 09/15/2010

This was originally published on PAOO on November 3rd, 2010.

My father was fond of saying you need three things in life – a good doctor, a forgiving priest, and a clever accountant


I have these little stories I use to keep perspective. They are a combination of fact and speculation. The proportions vary. I sometimes hear that being a CPA is very stressful. I can get into that, but then I have my perspective story. Sometime, during the early part of the second Gulf War, my daughter's eighth grade class wrote encouraging letters to our service people abroad. I wasn't surprised that she got a reply, but the person replying was a bit of a surprise. He was a major, the executive officer of a helicopter battalion. I tried to imagine what his job must be like. It involves seeing that machines that don't look like they should fly keep flying. And that's just the tip of the iceberg. My speculation was that he received a stack of letters and that faced with the challenge of making sure that his collection of extremely stressed young people appropriately answered the schoolchildren in a way that reflected credit on the Army, he answered them all himself. Regardless it was a nice letter and I hope that he is now full colonel at a nice post in pleasant circumstance or perhaps even better collecting a well earned lieutenant colonel's pension. And when ever I think I have stress I think about him.

I believe that the biggest hazard CPA's face is not stress, but envy. It is in the nature of things that most CPA's who do well have client's who do even better, much better. In a free capitalist society, the most highly compensated people will be the successful entrepreneurs. That does not mean that entrepreneurial activity is over rewarded. Unsuccessful entrepreneurship garners fairly heavy penalties. In the process of failure, they may generate some complicated accounting work, but not the revenue to pay for it. A practice where those clients predominate, unless it is that of some sort of workout specialist, will not last. So a prosperous CPA sitting down to eat with a collection of his most prosperous clients will often be the least prosperous person at the table. Ironically, the more prosperous the CPA is, the more likely that he or she will be the least prosperous person at that particular table.

The concept of value billing has some very sound reasoning behind it, but I also think that the envy factor is the source of some of its attraction. I couldn't help but notice it in the banter between professionals that was such a rich part of Fidelity International Currency, the epic tale of EMC founder Richard Egan's doomed tax shelters

On May 26, 2000, Denby sent Reiss an e-mail regarding the previous day's meeting and her discussions with Helios after the meeting concerning fees:


... after the meeting I discussed with Helios the fees. The fees are based on a 3% rate. If KPMG were not involved Helios would just pocket a larger percentage. Since our connection came from KPMG, Helios would pay them a referral fee anyway. I think at the same rate. So [their] involvement does not cost more but just results in reallocation of the base fee. I know from other situations this reallocation occurs simply from [our] getting the name [from] KPMG. We are in the wrong business!

The writer was an attorney and the recipient a CPA, who was CFO of a family office. She was expressing the same frustration that led the CPA's at KPMG into a new and interesting way to do business. She or her firm was apparently getting paid by the hour to find a brilliant maneuver to save Mr. Egan's tax dollars. KPMG had already invested some hours in designing a brilliant scheme. They would not get paid for the additional hours they spent applying these principles to Mr. Egan's situation. They would get paid a percentage of the tax savings while incurring a relatively small marginal cost.

The outcome of the whole enterprise was not pretty for KPMG or many of their clients. KPMG found itself fortunate to be in any business. They were even pressured by the federal government to stop paying defense costs for some of their partners, a tactic which back fired on the government on constitutional grounds, but you should go to the federal tax crimes blog if you want to read about that type of thing. More to the point of this post, none of the opinions that the Egans paid for protected them from the imposition of penalties. They were viewed as part of the package and tainted by a lack of independence.

The disdain for professional imprimaturs unsupported by work has moved beyond the Son of Boss unbalanced entries to a deal that tax professionals felt deserved a bit more respect. Canal Corporation and Subsidiaries was a deferral deal. Instead of selling a subsidiary the taxpayer contributed it to a partnership and took a large distribution. The debt that funded the distribution was allocated to the contributing partner, which avoids the disguised sale rules. Of course, they didn't really want a liability, so the guarantee that supported the allocation was pretty tenuous.

Not to worry, they got a "should" opinion, the highest assurance possible from none other than PWC. If you can't rely on the people who count the votes for the academy awards, who can you rely on ? Turns out the client should have been a little more diligent than just cutting a check and asking for the envelope, please :

Chesapeake paid PWC an $800,000 flat fee for the opinion, not based on time devoted to preparing the opinion. Mr. Miller testified that he and his team spent hours on the opinion. We find this testimony inconsistent with the opinion that was admitted into evidence. The Court questions how much time could have been devoted to the draft opinion because it is littered with typographical errors, disorganized and incomplete. Moreover, Mr. Miller failed to recognize several parts of the opinion. The Court doubts that any firm would have had such a cavalier approach if the firm was being compensated solely for time devoted to rendering the opinion.
We are also nonplused by Mr. Miller's failure to give an understandable response when asked at trial how PWC could issue a “should” opinion if no authority on point existed. He demurred that it was what Chesapeake requested. The only explanation that makes sense to the Court is that no lesser level of comfort would have commanded the $800,000 fixed fee that Chesapeake paid for the opinion


Chesapeake did not act with reasonable cause or in good faith as it relied on Mr. Miller's advice. Chesapeake argues that it had every reason to trust PWC's judgment because of its long-term relationship with the firm. PWC crossed over the line from trusted adviser for prior accounting purposes to advocate for a position with no authority that was based on an opinion with a high price tag—$800,000.

The Keller opinion sheds a different light on the subject. It is a follow up to the Keller case which I mentioned briefly at the dawn of this blog noting that the role of the accountant bordered on the heroic. There was a family limited partnership all set to go with assets identified, etc., etc. Then the matriarch dies before she can sign anything. Don't you hate when that happens ? So her estate tax of 147,000,000 or so was computed with no valuation discount. Then one of the family's accountants got the notion that maybe they had gone far enough. So they sued for refund and in August of 2009, they won. The case came up again to determine deductible fees. Although the court was very deferential to the executor/accountant, they decided that a $2,400,000 "bonus" for future worker was not ordinary and necessary. They also disallowed a $9,470,606 contingency fee to attorneys (presumably the ones who handled the litigation on the valuation discounts).

Pricing on Purpose is a really good book and it offers some valuable perspectives on approaches for billing for professional services. I think, though, that these decisions raise some issues on the value of tax services that are detached from the amount of work that is involved. It is almost as if when you try to bill based on the value, the value disappears.

My final reflection is advice for the financial professionals who have those twinges of envy when they see the big checks is to try three techniques. The first is to go to the kitchen and get a glass of water from the tap and drink it. While you do that reflect on how few people in world historical terms have had such easy access to reasonably potable water. The second is that the next time somebody in the street asks your for money, engage with them. Ask them when they have last eaten and then sit down and have lunch with them. (If they are professional pan handlers, they will find this rather frustrating). If all else fails do a google search on "KPMG Tax Shelter Prison". It may well be that Attorney Denby was in the wrong business, but that didn't mean KPMG was in the right business.

I'm not giving up on the quote identifying contest. The one at the top is from a film and at the risk of making it too easy I will say the real hero of the film was an accountant (although he is not the "hero" of the film). Also Xavier graduates and old people probably don't have an edge on this one.

FLP Good for the Family Business - But Maybe not the Family Jewels

JOHN W. FISHER and JANICE B. FISHER, Plaintiffs, v. UNITED STATES OF AMERICA, Defendant.09/01/2010

This was originally published on October 25th, 2010.

The family limited partnership is a fairly robust estate planning tool.  It has been under attack for some time, but generally stands up pretty well.  The IRS objection to it is understandable.  Somehow it seems that taking a bunch of stuff and putting the stuff into an entity should not produce a whole that is of lesser value than the sum of its parts.  It makes one wonder whether intellectual integrity is a key element in successful tax practice.  On a really bad day it makes one wonder whether lack of intellectual integrity might be a requirement.

The Fishers formed a Limited Liability Company (LLC) called Good Harbor Partners LLC.  Its principal asset was a tract of undeveloped land that bordered Lake Michigan.  In 2000, 2001 and 2002, they gave 4.762% interests in the LLC to each of their children. The Good Harbor operating agreement has significant restrictions on the transferability of interests.  The IRS argued that the restrictions on transferability should not be considered because the LLC did not constitute a bona fide business arrangement.  The court agreed stating :

The facts of this case are analogous to those in Holman . There, two donors created a limited partnership, funded it with common stock from a publicly traded company, and gifted limited partnership shares to their children. 601 F.3d at 765. There was no evidence indicating that the partnership employed a particular investment strategy or that the donors were “skilled or savvy investment managers whose expertise [wa]s needed or whose investment philosophy need[ed] to be conserved or protected from interference.” Id. at 770, 771. The donors retained exclusive control of the partnership, and their children could not withdraw from the partnership or assign their interests unless certain transfer conditions were met. Id. at 766. The Eighth Circuit affirmed the Tax Court's conclusion that the restrictions upon the children did not serve a bona fide business purpose because the partnership was not a ““business,” active or otherwise.” Id. at 770. In so holding, the Holman court distinguished a line of cases where active, ongoing business interests were preserved by the transfer restrictions at issue.See, e.g., id. at 771 (“The underlying assett in [Estate of] Bischoff [v. Comm'r, 69 T.C. 32, 39–40, 1977 WL 3667 (1977)] was a pork processing business organized, controlled, and managed by three families who sought to assure their continuing ability to carry on their pork processing business without outside interference, including that of a dissident limited partner.”).

This case is troubling in that there doesn't appear to be any of the sloppy execution that is common in failed family limited partnership.  It appears to call into question the use of this technique in the case of a single asset that does not have business characteristics.

Welcome to the Sausage Factory - RTFI

This was originally published on October 15th. 2010.

It's always a disappointment to me when something I get excited about turns out to be old news.  Such was the case with Fidelity International Currency which was the topic of Wednesday's post.  The decision, issued October 6 was an amendment of a decision issued in May.  I must admit that I have not done a word for word comparison. but skipping to the end I found that in the section headed "The Court does not reach the following issues":

(4.) Whether specific accuracy-related penalties should be assessed against any member or partner of Fidelity High Tech or Fidelity International

was dropped in the amended finding.

In the conclusion section we find added

(6.) The following accuracy-related penalties are applicable to any understatement of the income tax liability of Richard Egan arising from the treatment of the Fidelity High Tech and Fidelity International transactions on the tax returns of those entities for the years 2001 and 2002.
(a.) a 40% penalty for gross valuation misstatement pursuant to § 6662(a), (b)(3), and (h);

(b.) a 20% penalty for substantial valuation misstatement pursuant to § 6662(a) and (b)(3);
(c.) a 20% penalty for substantial understatement of income tax pursuant to § 6662(a), (b)(2), and (d)(2)(A); and
(d.) a 20% penalty for negligence or disregard of rules and regulations pursuant to § 6662(a) and (b)(1).

The penalties are alternatively, and not cumulatively, applied
 
There are some complex court jurisdiction issues in this case, which don't interest me an awful lot.  The Egans put up the estimated amount of tax that would be assessed if the partnership determination was upheld rather than go to Tax Court.  The penalties discussed above are not the partnership's penalties.  So I suppose there is some question as to whether the court is supposed to be ruling on them, particularly since they are not yet assessed.  Whether Mr. Egan's executors can go to tax court over the penalties is a question for the tax litigators.
 
The two primary emotions I experience in my wanderings through the ever expanding body of primary source tax documents are compassion and schadenfreude (Curious that you have to go to German for that term.) Mr. Egan certainly doesn't need my compassion, but I do think it is sad that he was vilified in the media as a tax cheat in the final year of a life of high achievement.  I think it would be tasteless and unprofessional to express schadenfreude with respect to any of the professionals involved in this debacle.  I will, however, single out one for a special type of compassion.  It is the "There, but for the grace of God, go I" variety of compassion.  You see there is  not very far distant alternate reality in which the Egans upset with their maltreatment by KPMG decide that leaving the warm embrace of a well established regional firm like O'Connon and Drew was a mistake.  Maybe there are some other firms in their region of similar size to O'Connor and Drew with somebody who knows about partnerships and tax shelters.  In that dystopia, the odds that this nightmare could have ended up on my desk are far from remote.  Thankfully, the Egans decided to stay national.  So my sympathy goes to Ron Wainwright of RSM McGladrey who got to sign the returns that KPMG wouldn't sign without disclosures that the tax attorneys said were not required.

In my previous post on this issue I analogized the people in the national firms who believed tax shelters still worked to isolated detachments of Japanese soldiers who were probably more prevalent in TV sitcoms than in real life in the fifties and sixties.  Implicit in this analogy is analogizing the Tax Reform Act of 1986 to the atomic bomb.  This may seem irreverent, but what can I say it's a metaphor.  And it is a pretty good one because tax shelters had already been dealt very heavy blows and might have went down anyway.  So in this elaborate metaphor Section 465, the at-risk rules, plays the role of ComSubPac, which sunk all the Japanese merchant ships. 

At any rate to explain my own role in the world of tax shelters in similar terms it is necessary to switch sides.  In this metaphor the Tax Reform Act of 1986 is the blitzkrieg.  My part of the tax shelter world, low income housing, was like Vichy France.  Our deals that were still in their pay in period were granted transitional relief.  Somebody told me that the fiscal trade-off for that was fiscal years for S corporations. Not a good trade from my viewpoint. We got a whole new credit, which meant all the new deals had to be redesigned and kept on trucking.  People capitalizing low income housing without much upside beyond the tax benefits was the way thing's were supposed to be.  This particular metaphor really sucks because it makes the national guys the Maquis and me, well never mind its a metaphor.  Basically we had to learn all the aggravating stuff in the 704(b) regulations and whatever other collateral damage the war against tax shelters did to Subchapter K, but we didn't have to hide in the woods while we were preparing returns.

I experienced this difference in world views in the mid-nineties when I was on the AICPA Tax Division's Partnership committee.  (Hey it really impressed somebody on our peer review team once).  When discussing some particularly arcane regulation a couple of the national guys indicated that they would be just as  pleased if it stayed unclear.  I must say that was exceptional.  Generally the committee was striving for clearer regulations.  I also remember that the anti- abuse regulations (1.701-2) were more or less hot off the presses at the time of our meeting.  There were a lot of bent out of shape people.  I, on the other hand, just looked at example 6 Special allocations; nonrecourse financing; low-income housing credit; use of partnership consistent with the intent of subchapter K and decided that there was nothing to worry about.

The Fidelity opinion got into the real nitty gritty of return preparation.  The transaction I explained in my previous post was executed by a partnership called Fidelity High Tech.  There were three partnership returns covering two years.  The reason for the extra return was that the plan required a "technical termination" meaning that a change in ownership created a new partnership for income tax purposes.  The "new partnership" was able to apply basis created by what a simple minded accountant like myself would see as an unbalanced entry to EMC stock the Egans had contributed to the partnership.  In a nice bit of presentation work, they got Mellon Bank to present a capital gain (loss) schedule which incorporated the new basis.  That can be a real challenge.  The court mentions that they didn't file form 8275, but they had an opinion that there transaction was somehow different.  What I see as the real "gotcha" is this:


 Because Fidelity High Tech did not use cash cost to compute the stepped-up basis, it was required to attach an explanation to Schedule D. No such explanation was attached.  An adequate explanation, as required by the instructions, would have included disclosure of the underlying transaction that resulted in the purported stepped-up tax basis used by Fidelity High Tech.

Back in the good old days, when we did returns by hand, my favorite review note was. RTFI - Read The Instructions.  I really think that if I had been sweating this return out, I would have caught that.  There would have been some sort of explanation.  Likely it would not have been sufficient, but if you look at the revenue procedures on adequate disclosure (e.g. Rev Proc 2010-15), sometimes thoroughly filling out the form is what does the trick.

Devil is in The Details

Originially published on PAOO December 29, 2009.

In June of 2007, the Estate of Sylvia Gore joined the ranks of failed Family Limited Partnership. The case is worthy of consideration, because it illustrates clearly why the partnerships fail. If you are going to set up a family limited partnership it is critical that you consult with a well qualified attorney. The attorney will create a package, more or less thick, of documents, more or less mysterious and will see that you sign them with witnesses, notarized, with an extra copy in her safe in case you lose yours. That’s service. That’s follow through. Valuation discounts are what tends to be at stake when the IRS attacks Family Limited Partnerships. Having had great service from your attorney, you probably think that when people lose it is because they didn’t hire a good attorney. Perhaps the documents weren’t witnessed. Maybe one of the incantations in the mysterious documents was missing. Maybe there wasn’t an extra copy in the safe, after they lost theirs.

The follow through needed is not the extra hour in the attorney’s office. The follow through will be many hours year in and year out in your accountant’s office. The clue to this is in the importance attributed to the extra copy in the attorney’s safe. Why doesn’t the accountant who has to prepare the income tax return for the partnership have a copy? Why don’t you need to look at your copy from time to time too? Here’s why:

each partner's capital account is increased by (1) the amount of money contributed by him to the partnership, (2) the fair market value of property contributed by him to the partnership (net of liabilities that the partnership is considered to assume or take subject to), and (3) allocations to him of partnership income and gain (or items thereof), including income and gain exempt from tax and income and gain described in paragraph (b)(2)(iv)(g) of this section, but excluding income and gain described in paragraph (b)(4)(i) of this section; and is decreased by (4) the amount of money distributed to him by the partnership, (5) the fair market value of property distributed to him by the partnership (net of liabilities that such partner is considered to assume or take subject to), (6) allocations to him of expenditures of the partnership described in section 705(a)(2)(B), and (7) allocations of partnership loss and deduction (or item thereof), including loss and deduction described in paragraph (b)(2)(iv)(g) of this section, but excluding items described in (6) above and loss or deduction described in paragraphs


This is one of the magic incantations that will appear in your agreement. If you ask your attorney how that paragraph should be reflected on the partnership’s tax return, he is likely to tell you that he doesn’t prepare partnership returns. That’s what accountants do. Now go to your accountant and ask her what that paragraph means. Among the possible answers are “That’s some stuff the attorneys have to put in the agreement. Why don’t you ask him what it means?”

So what did Sylvia Gore and her advisers do or fail to do that cost the estate $1,071,650 in federal estate taxes. Plus ten years of interest. Not to mention the cost of their fruitless efforts in the Tax Court.

In 1995 Sydney Gore met with his accountant in the hospital where he expressed to her “his concerns about preserving the wealth he had accumulated through his life's work, protecting his assets from waste, and conserving them for future generations”. The accountant had an idea, a very good idea. Form a family limited partnership. She’d never advised any of her other clients to take that step, but it seemed to the right thing to do here. She knew that she had limits, though:

“Ms. Bowers had little experience with family limited partnerships and had never recommended one to a client before she made the proposal to the Gore children, so she recommended that Ms. Powell, Mr. Gore, and decedent retain an attorney to further advise them about a limited partnership”

Apparently it didn’t occur to anybody that an accountant with more than a little experience with family limited partnerships might be able to bring something to the table.

What happened from here can hardly be blamed on the accountant. The partnership opened a bank account into which substantial sums were deposited. There was an assignment of marketable securities to the partnership. Unfortunately, title to the securities was not transferred to the partnership. The dividends from the securities were not deposited in the partnership’s bank accountant. When Mrs. Gore’s bills need to be paid they were paid sometimes from her personal accounts other times from partnership accounts.

Eventually returns need to be filed, which is when Ms. Bowers came back on the scene. What she did was what most competent accountants would try to do. Observing that what actually happened was not anything near like what was supposed to happen, she attempted to fix it all with journal entries. This process relies on one of the great intellectual breakthroughs that built the modern world – double entry bookkeeping first documented in a mathematical treatise over 500 years ago. It provides a built-in check that shows that you captured everything. It all has to balance. Debits equal credits.

When a check is written we credit cash. Then we have to debit something. Well the check went to Mary, so we debit Mary’s capital account. Unfortunately, by the terms of the partnership agreement we were not supposed to make a distribution to Mary. So we debit “Due from Mary”. Joe, on the other hand was supposed to get a distribution. Well either we won’t worry about that since it’s reflected in Joe’s capital or, if we want the percentages to be where they should be, we will credit “Due to Joe” and debit his capital account. When it’s all done the amounts on our records will agree to the statements (adjusted for the fact that they may not have the right names on them) and “it will all balance.” Mary will owe the partnership and the partnership will owe Joe. We’ll straighten it out next year or we’ll keep making journal entries to keep it straight.

I have learned a hard lesson that many accountants never quite get. When it comes to this “everything’s in balance” routine, almost nobody else cares. Here is some of what the court had to say about Ms. Bower’s efforts:

“The GFLP accounting records prepared by Ms. Bowers purport to show that decedent transferred ….”

“The accounting records also purport to show that after decedent executed the assignment, decedent allegedly sold the Commercial Federal CD, the savings bonds, a Valley National CD, and one of the Treasury notes to GFLP in exchange for a note payable to her from GFLP …”

The word “purport” or one of its forms (e.g. “purporting”) occurs six times. Here is the problem. You can get into law school with a liberal arts degree. They don’t teach double entry accounting in law school. If it’s taught in high school, it’s to kids not on the college track. You certainly don’t need it for a liberal arts degree. Judges are lawyers. It all balances and they don’t care.

I have no reason to doubt that if I looked at all the statements and agreements, I’d have concluded that Ms. Bower’s journal entries straightened things out. Likely most other accountants would reach a similar conclusion when they see that the cash ties and “it balances”. Much to our professional frustration, almost nobody else, but especially the judge, cares. The meticulous journal entries that “straighten” everything out in our minds, in the mind of the judge “purport”.

Also this year, the Estate of Concetta Rector lost to the tune of $1,633,049 plus about five years of interest. Here is an excerpt:

“The estate attempts to downplay the significance of the direct use of RLP funds to pay decedent's personal expenses by attributing that use to “errors”. In the light of John Rector's extensive financial expertise and his testimony that it never occurred to him that RLP should be reimbursed for such “errors” after they were discovered, we find that this argument lacks credibility”
This is nothing new. If you study the cases where taxpayers lose FLP cases, you will, almost always, if not inevitably, find that the failure was not one of a flawed plan. The failure was not following the steps transaction by transaction. If somebody is entitled to a distribution and has bills to pay, you distribute to them and let them pay their own bills. All entities have accounts and the payments in and out are the ones that belong to that entity. If a mistake is made it is fixed by a transfer of funds, not a journal entry that creates an indefinite “Due to”.
The moral of the story is that in order for the plan to work you must have coordination between the attorney who prepares the plan and the accountant who will be preparing the relevant returns. If you don’t want to trouble yourself with what entity should pay what bill or accept what deposit, etc, let that piece be handled by your professionals, also, but again in an integrated manner. There has to be somebody who cares what account is used, because that is their job.