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Summing It Up

Keeping you ahead of the curve with timely news & updates.


IRS Victory Highlights the Importance of Careful Estate Planning

IRS Undermines a Family Limited Partnership 

Author: Joe Aquino

Recently, the IRS celebrated another victory in its long-running campaign to challenge family limited partnerships (FLPs). In Estate of Lockett v. Commissioner, the agency attacked an FLP for being an invalid partnership under state law. Ultimately, however, it was the decedent’s estate planning that undermined the FLP, thus handing the IRS another win.

Widow takes ownership

Lois Lockett was predeceased by her husband, whose will established a trust for her benefit (Trust A). In 2000, as part of her estate planning, Lockett formed Mariposa Monarch, LLP under Arizona law. The partnership’s formal agreement, signed in 2002, named her sons Joseph and Robert as general partners. Lockett, the sons and Trust A were named as limited partners. At that point the parties hadn’t yet agreed on initial capital contributions or their percentage interests in Mariposa.

Shortly after the agreement was signed, Lockett and Trust A began funding Mariposa. Joseph and Robert never made any contributions. In 2003, Trust A was terminated, and Lockett became the owner of her limited partnership interest in the partnership. An amended agreement was executed to reflect this. The agreement continued to list the sons as Mariposa’s general partners, but an exhibit listed their mother as holding 100% of the partnership and each of the sons holding 0%.

When Lois Lockett died in 2004, Mariposa held assets worth more than $1 million. On its tax return, the estate valued Lockett’s 100% ownership interest in Mariposa at $667,000 after applying control and marketability discounts.

IRS raises state law

Initially, the IRS argued that Mariposa wasn’t a valid partnership under Arizona law. In that state, partnerships are defined as an association of two or more persons and are formed to operate a business for profit. The IRS contended that only Lockett contributed assets to Mariposa and that Mariposa wasn’t operated for profit.

Nevertheless, the court found that Mariposa was a valid partnership. Although the sons didn’t hold interests in it, Trust A contributed assets and was therefore a limited partner, satisfying the requirement of an association of two or more persons.

The court also found no requirement that an Arizona business engage in a certain level of economic activity. Moreover, it determined that Mariposa was operated to derive a profit. The partnership hired a financial advisor to manage its stock portfolio, purchased real estate that it leased and made loans requiring annual interest payments. It thus operated as a business for profit.

Trust termination found faulty

Unfortunately for the estate, the IRS had an alternative argument. Even though a valid partnership was formed, it had terminated at the time of Lockett’s death because she had acquired 100% of the interest in it. This occurred when Trust A was terminated in May 2003 (effective Dec. 31, 2002). At that point, Lockett had become the owner of Trust A’s limited partnership interest in Mariposa as well as being its sole partner.

Arizona law provides that a partnership is dissolved when a dissolution event previously agreed upon in the partnership agreement occurs. The Mariposa agreement established that the FLP would be dissolved when one partner acquired all of the other partners’ interests. So on Dec. 31, 2002, Mariposa dissolved and Lockett became the legal owner of its assets.

Many potential errors

Because the FLP had dissolved by the time of Lockett’s death, its assets were included in her gross taxable estate. If her sons had made contributions to fund their general partnership interests or she had gifted them with small interests in Mariposa, the FLP may well have withstood scrutiny and removed the assets from the estate.

Lockett’s mistakes were only a few of the many errors that can sabotage an FLP. To protect your clients from IRS attack, work with financial experts when drafting partnership agreements and making estate plans.

If you have any questions about FLPs or any other issue, give us a call at 716.847.2651, or you may contact us here.

Family Limited Partnerships

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Litigation Support: Weight vs. Admissibility

Court Allows Lost Profits Expert Testimony

Author: Tim McPoland
When an opposing party in a lawsuit challenges the admissibility of an expert’s testimony, the matter often comes down to one of two interpretations: whether the court believes the party’s arguments go to the admissibility of the evidence or to the weight of the evidence. The ruling in a federal district court case, BK Cypress Log Homes v. Auto-Owners Insurance Co., illustrates such determinations and highlights the need to present relevant expert testimony.

2 calculations

BK Cypress Log Homes sued Auto-Owners Insurance Company, alleging bad-faith conduct in the handling of a third-party claim. The defendant moved to exclude the plaintiff’s damages expert’s testimony on the grounds that his techniques weren’t generally accepted in the economic community. The expert used a two-part model, estimating lost profits with both the before-and-after and yardstick methods.

In his first calculation, he determined the plaintiff’s profit margins before and after the loss period. He attributed the difference to effects created by BK Cypress owner Jim Keeton’s participation in dispute-related activities that should have been handled by the defendant and that resulted in operational inefficiencies.

In the second calculation, the expert considered what the plaintiff’s sales would have been if the company had matched the industry average sales for the loss period. He used sales information from a log-home industry publication, as well as a “sample survey” of members of the Log Homes Council. Together, these sources yielded growth rate numbers for six companies.

Court rejects challenge

In the Florida court, the defendant asserted that the plaintiff’s before-and-after analysis wasn’t acceptable because it assumed that all loss in profitability was attributable to the defendant’s bad faith. In particular, Auto-Owners faulted the lack of data documenting:

  1. The amount of time Keeton spent attending to dispute-related matters, and
  2. The failure to account for time he would have expended on such matters even in the absence of bad faith.

The court concluded that the defendant’s criticisms should be raised through cross-examination of the expert and other witnesses regarding the assumptions underlying the damages calculation.

The defendant also argued that the yardstick analysis wasn’t acceptable because, among other things, the expert’s report didn’t establish that the businesses used to measure the losses were sufficiently similar to BK Cypress. The court denied the motion to exclude this part of the analysis — but without prejudice to the defendant’s right to exclude the testimony at trial if the plaintiff was unable to establish the survey data’s reliability through other evidence.

Rebuttable witness also rebuffed

Notably, the court also rejected the testimony of the defendant’s financial expert because he didn’t provide an estimate of damages. It characterized that expert’s testimony as a rebuttal opinion that failed to offer an alternative analysis methodology.

In the end, the court decided that the defendant’s expert’s testimony wouldn’t aid the jury in determining damages and would in fact be “redundant and unduly prejudicial.” Instead, the defendant was instructed to explore the criticisms in its expert’s report during cross-examination of the plaintiff’s expert and other witnesses.

If you have any questions about lost profits, testimony or any other litigation support issue, give us a call at 716.847.2651, or you may contact us here.

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