Death-Time Transfers to Family Members Via Entities Are Taxable
When an estate is large enough to encounter the federal estate tax (for deaths in years other than 2010), it is critical to utilize appropriate estate planning techniques to minimize (or eliminate) the impact of the tax. For the extremely wealthy, family limited partnerships can be an effective tool for lifetime gifting and for achieving valuation discounts on transferred interests at death. They are particularly useful when trying to pass a family business down from one generation to the next. Limited Liability Companies (LLCs) can also be an effective estate and business succession planning tool. But, these business structures must be used properly to achieve the desired benefits. In addition, there can be complications at the state level in those few states that have retained some sort of tax system applicable to a decedent’s estate or the transfer of property from an estate. Iowa is one of those few states. Over the past 18 months, the Iowa Department of Revenue has twice pointed out the problems that come into play at the state level when property passes to entities rather than persons at death.
Iowa Code §450.10
For property that passes at death, Iowa law taxes property differently based on how that property is classified. Under Iowa Code §450.10, when a decedent’s property (or the income from it) passes to “any firm, corporation, or society organized for profit, including fraternal and social organizations…”, the rate of tax is 15 percent on the amount of the transfer. However, for property that passes to a surviving spouse, parents, grandparents, great-grandparents, and other lineal ascendants, children, stepchildren, grandchildren, great-grandchildren and other lineal descendants, there is no tax at the state level.
Family Limited Partnerships – Post-Death Transfers
In the first case, the decedent’s will passed property to a family partnership. Under the Iowa inheritance tax regime, some persons that are related to the decedent are exempt from the tax. Others, less closely related are taxed, but at a reduced rate. The highest tax rate, however, is reserved for property passing to “firms.” The estate argued that because the transfer was made to a partnership that was owned solely by collateral descendants (an heir that is not a direct descendant, but is a brother, sister, aunt, uncle, cousin, nephew, niece or parent), the transfer should be taxed as if individually received by that class of descendants. The IDOR disagreed, noting that Iowa Code §450.10 treats a partnership as a unit without taking into consideration the individual members. As a result, the top rate of 15 percent tax rate applicable to a “firm” should be imposed. Estate of Patterson, IDOR Letter of Finding No. 07-70-2-0003 (May 10, 2007).
In the second case, the decedent died on June 15, 2008, with a will provision that left the decedent’s property to an LLC with instructions that units of ownership then be issued to her children (or their descendant’s) equally. The only purpose of the LLC was to transfer a quarter section of farmland to the children. After the decedent’s death, the LLC became an “operating LLC” and the family members discussed the farm’s management and named the children as the members of the board of directors. The estate filed a letter and tax return with IDOR claiming that the estate had zero tax liability because all of the decedent’s property passed to her heirs. But, IDOR disagreed noting that none of the property actually passed from the estate to the heirs – it passed to the LLC. Thus, the value of the property passing to the LLC was subject to tax at a 15 percent rate. IDOR reasoned that an LLC meets the statutory definition of “firm” contained in Iowa Code §450.10. IDOR noted that the decedent could have easily left her property directly to her children and completely avoided tax. That was particularly the case in light of the IDOR’s 2007 finding in the Patterson case. Clearly, the decedent’s will should have been changed to leave the property outright to the children – unless, of course, the idea was to assist the state with its current budget problems. In re Estate of Jennison v. Iowa Department of Revenue, No. 10DORFC004 (IDOR Admin. Hearings Div.Jul. 12, 2010).
The Center for Agricultural Law and Taxation does not provide legal advice. Any information provided on this website is not intended to be a substitute for legal services from a competent professional. The Center's work is supported by fee-based seminars and generous private gifts. Any opinions, findings, conclusions or recommendations expressed in the material contained on this website do not necessarily reflect the views of Iowa State University.