Estate of Mirowski v. Commissioner
By Louis A. Mezzullo, Esq.
Luce, Forward, Hamilton & Scripps, Rancho Santa Fe, CA
Mirowski Est. v. Comr.1
is the first taxpayer victory in a case involving §2036(a) since
the Schutt2 case was
decided in 2005. Ms. Mirowski died at the age of 73 on September 11,
2001 (9/11). She was a widow. Her husband died in 1990. He was the
inventor of the automatic implantable cardioverter defibrillator (ICD)
(commonly referred to as a pacemaker) and was entitled to 73% of the
royalties from the ICD patents, which he left to Ms. Mirowski. She
created separate irrevocable trusts in 1992 for each of her three
daughters, and transferred approximately 7% of the ICD patent
royalties to each of the trusts. After considering it for a year, Ms.
Mirowski formed the Mirowski Family Ventures L.L.C. (MFV) under
Maryland law on August 27, 2001. She then transferred her remaining
interest in the ICD patent royalties to MFV on September 1, 2001, and
then transferred approximately $62 million of marketable securities to
MFV in three transfers on September 5, 6, and 7, 2001. On September 7,
2001, she made gifts of a 16% interest in MFV to each of the
irrevocable trusts she had earlier created for each of her three
daughters, leaving her with a 52% interest in MFV. Judge Chiechi noted
that Ms. Mirowski never contemplated forming MFV without making the
gifts to her daughters' trusts. Although Ms. Mirowski had diabetes and
had developed a foot ulcer, at no time before September 10, 2001, did
she, her doctors, or her daughters think her death was imminent. The
IRS asserted a deficiency of approximately $14.2 million, based on
including all the assets in MFV in her estate under §§
2036(a), 2038(1), and 2035(a).
Judge Chiechi, who also decided Stone Est. v. Comr.,
3 another taxpayer victory in an
FLP case, held that the bona fide sale exception applied to the
transfers to MFV by Ms. Mirowski and that Ms. Mirowski did not retain
the enjoyment of the income from the transferred assets nor the right
to designate who was to enjoy the income from the transferred assets,
and therefore,§§2036(a), 2038(1), and 2035(a) did not apply.
Her decision was based on the facts in the case, the testimony of two
of the daughters, the terms of the MFV operating agreement, and
Maryland law. At the outset, Judge Chiechi determined that the
resolution of the issues presented did not depend on who had the
burden of proof. It seems that none of the cases dealing with the
application of §2036(a) have been decided on the basis of who had
the burden of proof.
The facts of the case indicated that Ms. Mirowski, from her
childhood in France, had always been concerned with keeping her family
together. She placed a great deal of emphasis on having the family
make decisions collectively. Nonetheless, she made her own investment
decisions, even up to her death. The facts also indicated that her
death was completely unexpected.
Judge Chiechi found the testimony of the two daughters who served
as witnesses concerning the facts in the case, including the reasons
for forming and transferring assets to MFV, to be completely candid,
sincere, credible, and reasonable. Judge Chiechi also pointed to the
terms of the MFV operating agreement that precluded Ms. Mirowski from
having the right to enjoy the income from the transferred assets or to
designate who would enjoy the income from those assets. Finally, Judge
Chiechi relied on Maryland law in determining that Ms. Mirowski did
not retain the right to enjoy the income or designate who would enjoy
the income from the transferred assets.
Based on the testimony of two of Ms. Mirowski's daughters, Judge
Chiechi found that Ms. Mirowski had the following legitimate and
significant nontax reasons for forming and transferring certain assets
to the partnership: (1) joint management of the family's assets by her
daughters and eventually her grandchildren; (2) maintenance of the
bulk of the family's assets in a single pool of assets in order to
allow for investment opportunities that would not be available if Ms.
Mirowski were to make a separate gift of a portion of her assets to
each of her daughters' trusts; and (3) providing for each of her
daughters and eventually each of her grandchildren on an equal
basis.
Judge Chiechi rejected each of the government's contentions in
challenging the bona fide sale exception. Because her death was
unexpected, the payment of estate taxes and other obligations of the
estate were not anticipated. The payment of gift taxes could have been
paid using the $7.5 million of assets Mrs. Mirowski retained or
financed through loans using those assets or her interest in MFV as
collateral. In addition, the gift taxes could have been paid from
expected distributions attributable to her 52% interest in MFV, which
would be receiving millions of dollars in royalty payments. Contrary
to the government's contention, Judge Chiechi found that MFV was a
valid functioning investment operation and that there did not have to
be a “business” reason for forming MFV. The lack of
negotiations was consistent with the fact that Ms. Mirowski was the
only contributor to MFV. The timing of the formation and funding of
MFV shortly before Ms. Mirowski's death was not a negative factor
because of her unexpected death. Judge Chiechi also noted that MFV did
in fact take advantage of investment opportunities that would not have
been available to the trusts if Ms. Mirowski had given the assets to
the trusts instead of forming MFV.
This case is in stark contrast to
Rector,4 and to some
extent, to some of the other cases that were IRS victories. Judge
Chiechi rejected many of the positions advocated by Judge Laro in a
number of cases he has decided dealing with FLPs. A legitimate and
significant nontax reason does not have to include a business reason.
Lifetime giving may be a significant nontax reason for creating the
entity. Negotiations between the transferor and the donees of the
interests in the entity are not a requirement in every case. There is
no requirement that someone other than the decedent contribute assets
to the entity. The payment of estate taxes and other post mortem
obligations does not necessarily mean there was an implied agreement
that the decedent would enjoy the income from the transferred
property. The fact that the decedent depended in part on expected
distributions from the entity, where it is clear the entity would have
substantial income, does not indicate there was an implied
agreement.
Fortunately for many situations where FLPs and FLLCs were created
for both tax and legitimate and significant nontax reasons, but where
the transferor died unexpectedly shortly after the formation and
funding, Judge Chiechi's holdings and the reasons for the holdings
should provide support for rejecting a challenge under
§§2036(a) or 2038(a)(1). However, because of Judge Chiechi's
emphasis on Ms. Mirowski's family history, the unexpected death of Ms.
Mirowski, and the credible testimony of two of Ms. Mirowski's
daughters, as well as the terms of the operating agreement and
Maryland law, this case should not provide solace in those situations
where the entity was clearly formed as a tax savings device, and any
nontax reason for creating the entity was a mere after thought and not
a motivating factor.
The key factors in favor of the taxpayer in this case were: (1) the
unexpected death of Ms. Mirowski; (2) the family history; (3) the
credible testimony of the daughters; (4) the existence of the ICD
patents and the litigation associated with them; (5) the terms of the
operating agreement that provided for the way distributions of
operating and capital proceeds were to be made; (6) the substantial
income MFV was expected to receive because of the ICD patent
royalties; and (7) Ms. Mirowski's retention of over $7 million of
assets.
This commentary also will appear in the July 10, 2008, issue of
the Tax Management Estates, Gifts and Trusts Journal. For more
information, in the Tax Management Portfolios, see Mezzullo, 812
T.M., Family Limited Partnerships and Limited Liability Companies,
and in Tax Practice Series, see ¶4095, Family Business
Entities.
1
T.C. Memo 2008-74.
2
Schutt Est. v. Comr., T.C. Memo 2005-126.
3
T.C. Memo 2003-309.
4
Rector Est. v. Comr., T.C. Memo 2007-367.
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