Estate of Bigelow v. Commissioner
503 F.3d 955, 100 A.F.T.R.2d (RIA) 6016, 27 A.L.R. Fed. 2d 753 (2007)
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Rule of Law:
Under 26 U.S.C. § 2036(a), the full value of property transferred to a family limited partnership will be included in a decedent's gross estate if there was an implied agreement that the decedent would retain the economic benefits of the property, and the transfer was not a bona fide sale for adequate and full consideration, which requires a legitimate and significant non-tax purpose.
Facts:
- In 1991, Virginia A. Bigelow transferred her residential property into a trust. After a debilitating stroke in 1992, she moved into an assisted-living facility.
- In 1993, the trust exchanged the original property for another rental property (the Padaro Lane property). To finance the transaction, the trust obtained loans for which Bigelow was personally liable, and the Padaro Lane property served as security.
- In December 1994, Bigelow's trust transferred the Padaro Lane property to a newly created family limited partnership, Spindrift Associates, Ltd., in exchange for partnership interests.
- Despite transferring the property, Bigelow's trust remained personally liable for the debts secured by the property.
- After the transfer, Bigelow's personal income was insufficient to cover her living expenses and debt payments.
- The partnership used the rental income from the Padaro Lane property to make the monthly payments on the loans for which Bigelow was personally liable.
- Bigelow's son, acting as trustee, made approximately 40 informal, interest-free fund transfers between the partnership and Bigelow's trust to cover her expenses.
- Virginia A. Bigelow died on August 8, 1997.
Procedural Posture:
- The Estate of Virginia A. Bigelow filed a federal estate tax return with the Internal Revenue Service (IRS), applying a discount to the value of a partnership interest.
- The Commissioner of Internal Revenue audited the return and issued a notice of deficiency for $217,480.05, arguing the full value of the underlying property should be included in the estate.
- The Estate petitioned the United States Tax Court, a court of first instance, to contest the deficiency.
- Following a bench trial, the Tax Court found for the Commissioner and upheld the deficiency determination.
- The Estate, as appellant, appealed the Tax Court's decision to the United States Court of Appeals for the Ninth Circuit, with the Commissioner as appellee.
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Issue:
Does 26 U.S.C. § 2036(a) require the inclusion of the full fair market value of a residential property in a decedent's gross estate when the decedent transferred the property to a family limited partnership but continued to benefit from the property's income to pay her personal debts, and the partnership lacked a legitimate non-tax business purpose?
Opinions:
Majority - Gould, Circuit Judge
Yes. Under 26 U.S.C. § 2036(a), the full value of the Padaro Lane property must be included in Virginia A. Bigelow's gross estate because she retained lifetime enjoyment of the asset through an implied agreement, and the transfer was not a bona fide sale for adequate consideration. The court found an implied agreement existed because the transfer left Bigelow with insufficient income to meet her financial obligations, and the partnership used rental income from the property to service her personal debts. Furthermore, the property continued to secure loans for which she was personally liable. The transfer did not qualify for the 'bona fide sale' exception because there was no legitimate and significant non-tax purpose for creating the partnership; its proffered justifications, such as liability protection and management efficiency, were not supported by the facts. The transaction's structure and the subsequent conduct of the parties indicate it was a testamentary substitute intended to reduce estate tax liability rather than a genuine business arrangement.
Analysis:
This decision reinforces the high level of scrutiny courts apply to family limited partnerships (FLPs), especially those holding passive assets. It solidifies the principle that the 'bona fide sale' exception to § 2036(a) requires a legitimate and significant non-tax purpose, which cannot be merely pretextual. By focusing on objective factors like whether the transferor retained sufficient assets for self-support and whether partnership formalities were respected, the case provides a clear warning to estate planners. The ruling makes it significantly more difficult to use FLPs solely as a vehicle to generate valuation discounts for estate tax purposes without a demonstrable, non-testamentary business rationale.
