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Further, the family was not financially dependent upon the LLC –the decedent had sufficient funds outside of the LLC for her living expenses at her death. The Purdue family LLC was managed like a legitimate business-the children heard presentations from the LLC’s investment manager, approved annual cash distributions and generally operated the business according to the operating agreement. Importantly, however, the LLC was actually managed according to the management agreement-in fact, the loan from the QTIP trust was only made because the operating agreement required unanimity in making financial decisions and one beneficiary refused to make the LLC assets available for paying the estate tax. The Tax Court found that these were legitimate non-tax reasons so that the LLC interests were not included in the decedent’s estate. Those reasons were: (1) relieving the decedent of the burden of managing the investments, (2) consolidating the investments with a single advisor to reduce volatility under a written investment plan, (3) educating the children to jointly manage an investment company, (4) to avoid repetitive asset transfers among multiple generations, (5) to create common ownership of assets for efficient management and meeting minimum investment requirements, (6) to provide voting and dispute resolution rules and transfer restrictions and (7) to provide the children with a minimum annual cash flow. The Tax Court disagreed, however, finding that the seven non-tax reasons for forming the LLC were compelling. The IRS challenged the estate on this point, finding instead that the LLC was created primarily to transfer wealth to the next generation while avoiding transfer taxes. Further, the estate was required to show that there were valid non-tax reasons for creating the family LLC. Generally, under IRC Section 2036, property transferred to a trust in which a decedent holds an ownership interest is included in his or her gross estate unless that property is transferred for adequate consideration. Trust beneficiaries and the QTIP trust loaned the estate funds to pay the estate tax, and the estate attempted to deduct interest paid on the loan, which the IRS challenged. Purdue (the decedent) and her husband had retained the right to income and distributions from the LLC assets, although the decedent had approximately $3.25 million outside of the LLC and trusts.Īfter the decedent’s death, the IRS attempted to collect over $4 million in estate taxes and challenged the LLC structure. Purdue died, he created a bypass trust, a qualified terminable interest property (QTIP) trust and a GST-exempt trust, each of which owned a portion of the LLC. The LLC’s operating agreement provided several non-tax reasons for creating the LLC, including (1) avoiding fractionalizing ownership, (2) keeping the assets within the extended family, (3) protecting the assets from future unknown creditors and (4) providing flexibility in managing the assets that would be unavailable in other entities. Over time, the trust was funded with interests in the LLC in proportion to the gift tax annual exclusion each year, and each beneficiary had the right to withdraw up to the gift tax annual exclusion amount or a per capita share of the assets transferred each year. They funded a Purdue Family LLC with approximately $22 million in marketable securities and other assets and simultaneously created a trust to benefit the Purdue’s descendants and spouses. Purdue had five children and multiple grandchildren and great-grandchildren, along with a potential estate that was worth about $28 million-well in excess of the current $5.49 million per person estate tax exemption amount. |
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