Using Entity Assets to Pay Estate Obligations After Death
Much has been written about what to do and what not to do in establishing and administering family limited partnerships (“partnerships”) to survive attacks by the Internal Revenue Service (IRS) under IRC § 2036. Most discussions have focused on measures before a taxpayer’s death. The taxpayer’s and estate planner’s dance with the IRS, however, continues even after the taxpayer’s death.
For example, assume that Mr. Earnest’s estate consists of $5 million in liquid assets and a 65% interest in Hopefully No Bad Facts, L.P., appraised by an independent qualified appraiser at $18.5 million. Assuming for purposes of this article that Congress legislates an exemption of $3.5 million and a 50% estate tax rate, the taxpayer’s projected estate tax liability would be $10 million. Mr. Earnest’s estate lacks sufficient liquid assets to pay the estate taxes due. Ms. Justice (Mr. Earnest’s executor) asks you whether the partnership’s assets can be used to pay estate expenses and the remaining portion of the estate tax liability. You know that financial transactions between Mr. Earnest’s estate and the partnership may provide the IRS with ammunition to argue that Mr. Earnest had an implied agreement to retain the enjoyment of the property transferred to the partnership and therefore, in the IRS’s view, IRC § 2036 would apply.
In this article, the authors will summarize a number of cases that have addressed post-death payments from partnerships and provide a summary of alternative approaches to provide liquidity to pay estate administration expenses, including estate and inheritance taxes.
Special thanks to Jim Hillhouse (WealthCounsel) for bringing this article to my attention.