Originally published on forbes.com.
Estate of Lois L. Lockett, et al. v. Commissioner, TC Memo 2012-123
One of the most fundamental principles of partnerships is that to have a partnership, you need partners. That is plural. So if somebody is getting 100% of everything, there may be a problem. That is what the Lockett family found when it was denied any valuation discounts on the assets in the Mariposa partnership included in the Estate of Lois Lockett.
Sometimes I think the hardest thing about family limited partnerships is that they involve families. That probably accounts for some of the difficulties in getting the Lockett family’s partnership called Mariposa going. Here is some of the story. Lois Lockett, a widow, had two sons, four grandchildren, a step grandchild, two daughters-in-law and an ex-daughter-in-law. Guess who the moving force was in getting the estate plan moving ?
Mary, Mrs. Lockett’s ex-daughter-in-law, was a financial planner who had advised Mrs. Lockett and assisted with her financial affairs for a number of years. David Haga who had represented Mrs. Lockett from 1996, was her estate planning attorney, and Gerald Bernard was her accountant. On February 11, 2000, Mrs. Lockett created a revocable trust, the Lois L. Lockett Trust (Lockett Trust). The Lockett Trust document named Mrs. Lockett and Mary as cotrustees. Mary and Mr. Haga also recommended that Mrs. Lockett create a family limited partnership. The Lockett family being close, Mrs. Lockett decided to involve Joseph, Robert, and Mary in the creation of the partnership. With so many people involved, a good amount of indecision arose which stalled the orderly creation of the partnership.
Joseph and Robert thought it would be a good idea to hire their own lawyer. Bring in another lawyer. That is sure to speed things up. It may have brought things to a head anyway.
On October 12, 2001, Mary wrote a letter signed by herself and Mrs. Lockett to Mr. Haga in reference to their September meeting. In the letter Mary expressed reservations about having Mr. Miller involved in the drafting of the partnership agreement, essentially requesting that his changes be ignored. Mary also recommended that she be named a general partner so that she could protect Mrs. Lockett’s limited partnership interest. Mary recommended a number of other changes and stated that once those changes were made she would encourage Mrs. Lockett to sign the partnership agreement.
Joseph and Robert had always deferred to Mary’s judgment when it came to their mother’s finances. Mary had been the driving force behind the creation of Mrs. Lockett’s estate plan and the formation of Mariposa. However, Joseph and Robert became suspicious of Mary’s motives. They moved their mother to a new assisted living facility so that she would be farther away from Mary and closer to them. In January 2002 Joseph and Robert decided to exclude Mary from further involvement in Mrs. Lockett’s financial affairs. On March 2, 2002, Mrs. Lockett executed a durable power of attorney removing Mary as her attorney-in-fact and appointing Joseph and Robert in her stead. On that same date, Mrs. Lockett executed a first amendment to the terms of the Lockett Trust removing Mary as cotrustee and appointing Joseph and Robert to serve as cotrustees.
There was still a lot of indecision, though.
The Mariposa agreement named Joseph and Robert as general partners and Mrs. Lockett, Joseph, Robert, and Trust A as limited partners. Even without Mary’s involvement the indecision continued. At the time the Mariposa agreement was signed, Mrs. Lockett, Robert, and Joseph had still not agreed upon initial capital contributions or their percentage interests in Mariposa.
Ultimately Robert and Joseph would never make any contribution for their general partnership interests. They subsequently tried to argue that there was an implicit gift to them of a 1% interest, that they provided services and later on that a contribution that Mrs. Lockett made in the amount of $125,000 was actually made on their behalf giving them an 11.68% interest.
When Mrs. Lockett died her interest in the partnership, which was listed as 100%, was valued at $667,000. The underlying assets were stipulated in the case as being worth $1,106,841. There were discounts for lack of control and marketability. The IRS tried to argue that there never was a partnership at all because there was no business conducted. The Court did not buy that argument:
We agree there was minimal economic activity, but we find no requirement that an Arizona business engage in a certain level of activity. Moreover, we find that Mariposa was operated to derive a profit. Mariposa hired Mr. Russell to manage its portfolio of stocks, purchased real estate which it leased, and made loans requiring annual interest payments. Accordingly, we find that Mariposa operated a business for profit.
There was a problem, though, which turned out to be insurmountable. I find the use of the passive voice here interesting – In May 2003 a decision was made to terminate Trust A. The dissolution of Trust A which involved the transfer of its interest in Mariposa to Mrs. Lockett is what made her a “100% partner”. What were they thinking ? They must not have been thinking that they terminated the partnership, but that is what the IRS and, more importantly, the Tax Court ended up thinking:
Article 9.1 of the Mariposa agreement provided Mariposa would be dissolved upon the acquisition by a partner of all the interests of the other partners. Therefore, Mrs. Lockett’s acquisition of Trust A’s limited partnership interest caused the dissolution of Mariposa under Arizona law. On December 31, 2002, Mrs. Lockett became the legal owner of all of Mariposa’s assets pursuant to Arizona law.
The case also got into several loans that Mrs. Lockett made to her heirs. Even though no payments were made on them, the ones that were supported by promissory notes were treated as loans rather than gifts. I would have recommended that Robert and Joseph fund their general partner contributions from a source other than the loans, but it would certainly have been better if they had done that rather than not funding them at all. Alternatively a well documented gift to them of a small interest in Mariposa might have done the trick. Finally you have to wonder about the decision that was made to terminate Trust A. I hope it accomplished some greater purpose than saving on filing one return.
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