May, 2007 | Issue 19
Introduction
The Commonwealth Court of Pennsylvania upheld a lower court decision which disallowed an inheritance tax valuation discount on a family limited partnership which had been accepted by the IRS. 2007 Pa. Commw. LEXIS 182, In Re The Estate of Helen H. Berry, Deceased Late of Venango County Pennsylvania, Appellant, No. 1485 C.D. 2006 (COMMONWEALTH COURT OF PENNSYLVANIA April 24, 2007)
The Partnership
The Estate of Helen H. Berry included an interest in a family limited partnership (FLP). The partnership interest had a net asset value of $2,880,000, consisting of cash and marketable securities.
Following her death, on March 30, 2003, the Estate’s executors filed both a Federal Estate Tax return and a Pennsylvania Inheritance Tax return. In valuing the FLP for the returns, the executors applied a 33% discount to the asset value for lack of control and marketability. The IRS accepted the Federal Estate Tax return as submitted by the executors, allowing the 33% discount. The Pennsylvania Department of Revenue, on the other hand, disallowed the discount.
The First Two Appeals
The Estate appealed the Department’s decision to the Board of Appeals, which upheld the Department of Revenue’s finding. The Estate appealed from that decision to the Venango County Orphan’s Court, which found that the FLP did not operate as a legitimate business enterprise and refused to reverse the Board of Appeals.
The Third Appeal
The Estate appealed this decision to the Commonwealth Court of Pennsylvania. The Estate raised two issues for review: 1) whether the FLP serves a legitimate business purpose, and 2) whether the trial court erred in refusing to reverse the Department of Revenue’s decision to disallow the valuation discount despite the fact that the IRS had allowed it.
Both parties agreed that there are no Pennsylvania Department of Revenue regulations pertaining to family limited partnerships and that, typically, the Department uses criteria that mirror those of the IRS when there is no applicable state regulation. The Estate argued that the fact that the IRS allowed the discount is dispositive.
The Decision
The Commonwealth Court disagreed. While agreeing that it is appropriate to use the same regulations that the IRS used in making the determination, the Court said that “The conclusion that the IRS reached, however,… is binding neither upon the Board nor upon this Court.”
Finding itself not bound by the IRS decision, the Court then turned to address the Board’s finding that the FLP served no legitimate business purpose. It considered the testimony of the family’s CPA to the effect that the purpose of the FLP was to shield assets from liability, preserve the decedent’s estate and save tax dollars. The Partnership Agreement, in its statement of purpose, was in accordance with this testimony. The Court noted that the only activity of the partnership was the sale of stocks to fund Decedent’s distribution of the partnership’s assets, and that Decedent remained the principal economic beneficiary of her contributed property, withdrawing cash from the partnership for personal use and for the bestowal of gifts
The Court concluded as follows; “There is sufficient record evidence to support the trial court’s factual findings that (the FLP) did not operate as a legitimate business enterprise. The trial court did not err as a matter of law in affirming the Board.”
