Too Much Control Dooms Another FLP

In Estate of Bongard v. Commissioner, 124 TC No. 8 (2005), the court determined that the assets transferred to a family limited partnership were still in the decedent’s estate leading to a tax deficiency of millions of dollars.

Here is the summary as prepared by the tax court:

In 1980, D incorporated Empak, Inc. In 1986, D established an irrevocable stock accumulation trust (ISA Trust) and funded it with some of his Empak stock. In the mid-1990s it was determined by Empak’s board of directors and advisers that pooling all of D’s family’s Empak stock in a holding company, WCB Holdings, LLC. (WCB Holdings), would better position Empak for a corporate liquidity event, which was necessary to raise capital and remain competitive. On Dec. 28, 1996, D and ISA Trust capitalized WCB Holdings by transferring to WCB Holdings their respective shares of Empak stock, and in exchange received WCB Holdings class A and class B membership units. Each class of membership units was further divided into governance and financial units, the class A governance units being the only units with voting rights.

On Dec. 29, 1996, D and ISA Trust formed the Bongard Family Limited Partnership (BFLP). To capitalize BFLP, D transferred all of his WCB Holdings class B membership units to BFLP in exchange for a 99-percent limited partnership interest, and ISA Trust transferred a portion of its WCB Holdings class B membership units to BFLP in exchange for a 1-percent general partnership interest. On Dec. 10, 1997, D made a gift of a 7.72-percent partnership interest to his wife. D made no other gifts of his BFLP interest before his death on Nov. 16, 1998.

The IRS issued a notice of deficiency to the estate on Feb. 4, 2003, which, among other things, returned to decedent’s gross estate, under secs. 2035(a) and 2036(a) and (b), I.R.C., all of the Empak shares decedent had transferred to WCB Holdings.

The estate argues that sec. 2036(a), I.R.C., is not applicable to either D’s transfer of Empak shares to WCB Holdings or D’s transfer of his WCB Holdings class B membership units to BFLP because each transfer was a bona fide sale for adequate and full consideration. The estate argues, in the alternative, that even if the bona fide sale exception was not satisfied by each transfer, D did not
retain a sec. 2036(a)(1) or (2), I.R.C., interest in the property he transferred in either transaction.

Held: D’s transfer of his Empak stock to WCB Holdings satisfied the bona fide sale exception because D possessed a legitimate and significant nontax reason for the transfer.

Held, further, D’s transfer of WCB Holdings class B membership units to BFLP did not satisfy the bona fide sale exception.

Held, further, an implied agreement existed whereby D retained a sec. 2036(a), I.R.C., interest in the WCB Holdings class B membership units he transferred to BFLP.

Held, further, WCB Holdings class B membership units allocable to the 7.72-percent partnership interest in BFLP D gave to his wife are included in D’s gross estate under sec. 2035(a), I.R.C.

For commentary on this case, see Helen W. Gunnarsson, New Limits for Family Limited Partnerships, 93 Ill. B. J. 385 (2005).