Kimbell v. United States
93 A.F.T.R.2d (RIA) 2400, 2004 U.S. App. LEXIS 9911, 371 F. 3d 257 (2004)
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Rule of Law:
A transfer of assets to a family limited partnership in return for a pro-rata partnership interest qualifies for the 'bona fide sale for adequate and full consideration' exception under I.R.C. § 2036(a) if the transaction is substantiated by legitimate, non-tax business purposes and does not deplete the transferor's estate.
Facts:
- Ruth A. Kimbell, a 96-year-old woman, held significant assets, including working interests in an oil and gas business founded by her late husband.
- In 1991, Mrs. Kimbell established the R.A. Kimbell Living Trust (Trust), which she and her son, David A. Kimbell, administered as co-trustees.
- In January 1998, the Trust and David Kimbell and his wife formed a limited liability company (LLC), with the Trust acquiring a 50% interest and David being the sole manager.
- Later in January 1998, the Trust and the LLC formed the R.A. Kimbell Property Co., Ltd. (Partnership).
- The Trust contributed approximately $2.5 million in assets (including cash, securities, and oil and gas interests) to the Partnership in exchange for a 99% limited partner interest.
- The LLC contributed approximately $25,000 in cash for a 1% general partner interest.
- The Partnership's stated purposes included asset protection from creditors, centralized management, and preventing the fractionalization of family assets.
- Mrs. Kimbell retained over $450,000 in personal assets outside the Partnership for her living expenses and died approximately two months after the Partnership's formation.
Procedural Posture:
- David A. Kimbell, as executor of his mother's estate, filed a federal estate tax return claiming a 49% valuation discount on the decedent's partnership and LLC interests.
- The Internal Revenue Service (IRS) audited the return, disallowed the discount, and included the full value of the transferred assets in the gross estate under I.R.C. § 2036(a), assessing additional taxes.
- The estate paid the additional tax and filed a lawsuit against the United States in a U.S. District Court, seeking a refund.
- On cross-motions for partial summary judgment, the district court granted the government's motion, ruling that the transfer was not a bona fide sale for adequate and full consideration.
- The estate, as the appellant, appealed the district court's judgment to the U.S. Court of Appeals for the Fifth Circuit.
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Issue:
Does a decedent's transfer of assets to a family limited partnership in exchange for a pro-rata partnership interest constitute a 'bona fide sale for adequate and full consideration' under I.R.C. § 2036(a), thereby exempting the full value of the transferred assets from inclusion in the decedent's gross estate?
Opinions:
Majority - W. Eugene Davis
Yes. A transfer of assets to a family limited partnership in exchange for a pro-rata partnership interest can constitute a 'bona fide sale for adequate and full consideration' under I.R.C. § 2036(a). The court reasoned that the bona fide sale exception has two components. First, a 'bona fide sale' does not require an arm's length transaction between unrelated parties; rather, it requires a genuine transaction with a legitimate, non-tax business purpose. Here, undisputed evidence showed the Partnership was formed for substantial business reasons, such as providing liability protection for Mrs. Kimbell’s oil and gas working interests and ensuring centralized management of family assets. Second, 'adequate and full consideration' exists when the exchange does not deplete the transferor's estate. The court established a three-part test for this: 1) partnership interests received are proportionate to assets contributed, 2) assets are properly credited to capital accounts, and 3) liquidation proceeds are distributed according to capital accounts. Because these objective criteria were met, the transfer was for adequate and full consideration, regardless of any subsequent valuation discounts applied to the partnership interest for lack of marketability or control.
Analysis:
This decision represents a significant taxpayer victory and provides a clear framework within the Fifth Circuit for structuring Family Limited Partnerships (FLPs) to withstand IRS scrutiny under § 2036(a). It firmly rejects the IRS's argument that the discounted fair market value of a partnership interest proves a lack of adequate consideration at the time of transfer. By focusing on objective factors and legitimate non-tax purposes, the ruling establishes that even transactions between family members completed shortly before death can be respected for estate tax purposes, provided they are not mere 'sham transactions' or a 'recycling of value' motivated solely by tax avoidance.
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