Taxpayer Wins Victory in Wealth Transfer Case

New article by Michael Trainotti

On March 26, 2008 the IRS lost a major case in the tax court dealing with family wealth transfers not being included in the decedent’s estate. As will be discussed below, the tax court found that there was a sufficient business non tax purpose in creating a LLC to manage family assets for the next generation and making lifetime gifts into trusts. This is a very important point in the successful outcome against the IRS.

Facts of Case. Decedent and her physician husband had a long history of having and encouraging a close knit family, having three daughters and regularly taking an annual family vacation which included family meetings considering business and investment matters and often involving accountants and attorneys as invitees. Dr. Mirowski had been developing an implantable defibrillator device and to pursue its development and funding, the family moved to the U.S. in 1968, and within 10 years Dr. Mirowski was successful in developing an implantable cardioverter defibrillator(ICD) thereafter achieving success with implantation in humans.

Mrs. Mirowski at all times was an astute and involved financial manager, as stated by the court, “a careful,
deliberate and thoughtful decision maker, especially with respect to financial matters.” She worked with an investment advisor at Goldman Sachs to handle a rapidly growing investment portfolio, eventually agreeing to the principle of diversification, and in early 2001 consolidated all investments with Goldman Sachs.

The concept of using an investment entity, here a limited liability company (LLC), as a vehicle for pooling of family assets first came up during a presentation to decedent by U.S. Trust.

Thereafter, the family attorney, on August 31, 2000, provided draft articles of organization and an operating agreement for the proposed LLC; however, there was about a year’s delay since decedent usually waited for the annual family meeting to consider major decisions so as to involve her daughters in considering same. Thus, it was August 14, 2001 before the LLC plan was reviewed with the family members, and in the meantime, Mrs. Mirowski was suffering from a foot ulcer and was being treated for this affliction considering her diabetic condition. However, her overall health had not, and was not, deteriorating.

The LLC documents were finalized following the August 14, 2001 meeting, and now, beginning at page 18 of the Tax Court’s opinion, the findings of fact chronicle the purposes of the LLC, the steps in formation and funding, the gifts by the initial sole member, the decedent, of 16% interests in the LLC to each of the daughter’s trusts, all leading up to the sudden September 10, 2001 deterioration of decedent’s health and her death the next day, the infamous 911 tragedy.

Tax Court Analysis And Conclusions. The Tax Court considered first the transfers of assets by decedent to the LLC, and separately the gift transfers by decedent to her daughters’ trusts. These were deemed separate transactions, even though the overall intention of forming MFV was to fund it and then that the sole member, the decedent, would make gifts of interests therein.

The legitimate and significant non-tax reasons for creating the entity were identified, the court stating, at page 50 of its opinion, that these reasons were as follows:

1. Joint management of the family’s assets by her daughters and eventually her grandchildren,

2. Maintenance of the bulk of the family’s assets in a single pool of assets in order to allow for investment opportunities that would not be available if Ms. Mirowski were to make a separate gift of a portion of her assets to each of her daughters or to each of her daughters’ trusts, and

3. Providing for each of her daughters and eventually each of her grandchildren on an equal basis.

Decedent retained outside MFV significant assets, totaling $7.5 million in overall value, of which over $3 million was in liquid form. The court found that there was no express or implied agreement that any LLC distributions would be made to allow decedent to pay gift tax on the gifts of MFV interests. Decedent had substantial liquid assets in her name, the LLC was mandated to make annual distributions of net cash flow, and decedent could have borrowed as needed to pay the gift tax due.

Then the court turned to the gifts by decedent of a 16% MFV interest to each of the three daughters’ trusts.First, no express retained income or enjoyment retention under 2036(a)(1) was found by the Tax Court. The IRS contended that since decedent was the managing member (General Manager) of MFV, her authority “included the authority to decide the timing and amounts of distributions from MFV.”

Not so, said the court, pointing to the operating agreement and State law limitations on such General Manager authority. As to the operating agreement, the provisions regarding annual mandated distributions, the required distributions of capital asset disposition proceeds (including in liquidation, etc.) were significant limitations on the General Manager’s authority, couple with general fiduciary duties.