A week. That’s how long Nancy Powell lived after her son transferred $10 million of her cash and securities into a family limited partnership, took a 99% LP interest in return, and gifted that interest to a charitable lead annuity trust. The transactions happened the day after she was declared incapacitated. There were no business operations. The son exceeded his authority under the power of attorney to make the gift. The Tax Court’s response to the “what happened” was predictable: the assets came back into the gross estate. The estate tax deficiency was $5.88 million. The gift tax deficiency was $2.96 million.
What wasn’t predictable — and what makes Estate of Powell v. Commissioner (148 T.C. No. 18, May 18, 2017) a case every T&E practitioner needs to understand — is how the court calculated the includible amount. For the first time, the Tax Court applied §2036(a)(2) to a decedent who held only a limited partnership interest, found that a limited partner’s dissolution voting rights were enough to trigger inclusion, treated general-partner fiduciary duties as “illusory” in a family context, and then introduced a novel framework under §2043(a) to address the double-inclusion problem that nobody had asked it to solve. The majority called it filling a “lacuna.” A group of concurring judges called it unnecessary judicial activism. For practitioners, it changed the math on every FLP that relies on valuation discounts to reduce estate and gift tax exposure.
What Actually Happened
Nancy Powell’s son Jeffrey created a family limited partnership nine days before her death. He named himself general partner and, acting as trustee of Nancy’s revocable trust, transferred approximately $10 million in cash and marketable securities to the FLP in exchange for a 99% limited partnership interest. The sons’ contributions were unsecured promissory notes. That same day, Jeffrey, acting under a power of attorney, transferred Nancy’s 99% LP interest to a charitable lead annuity trust (CLAT) directing an annuity to the family’s private foundation, with the remainder passing to trusts for the two sons.
After running the numbers through valuation discounts for the LP interest and then a second discount to arrive at the remainder interest gifted via the CLAT, the Form 706 reported a net transfer of roughly $1.66 million on $10 million in underlying assets. The IRS saw it differently: it asserted an estate tax deficiency of $5.88 million and a gift tax deficiency of $2.96 million. Nancy’s estate didn’t even bother to argue that the bona fide sale exception to §2036(a) applied — there was no legitimate non-tax business purpose for the FLP, and the discount meant the exchange wasn’t for full and adequate consideration.
The Two Holdings That Matter
First: §2036(a)(2) reaches limited partners. This was the headline. Before Powell, practitioners generally worried about §2036(a)(2) when the decedent held a general partner interest or controlled the general partner. Powell extended it further. The Tax Court held that Nancy, acting in conjunction with her sons, had the ability to dissolve the partnership and thereby designate who would possess or enjoy the transferred assets. A limited partner’s statutory right to vote on dissolution was enough.
The court also found that any fiduciary duties constraining Jeffrey’s discretion as general partner were “illusory” — because he was family, because he was also the decedent’s attorney-in-fact, and because there were no third-party partners to enforce those duties. This reasoning, consistent with the court’s earlier holding in Estate of Strangi, means that in a family-only FLP, the fiduciary duties that theoretically limit a general partner’s discretion over distributions may not be enough to prevent §2036(a)(2) from applying.
Second: the “doughnut hole” under §2043(a). This is the framework that divided the court and that practitioners need to understand mechanically. Here’s the problem the majority was trying to solve: if §2036(a) includes the full, undiscounted value of the assets transferred to the FLP in the gross estate, and the decedent also holds an LP interest that’s separately includible under §2033, there’s a double-inclusion problem. The same economic value gets taxed twice.
The traditional approach was simple: disregard the FLP and include the underlying assets. No partnership interest, no double counting. The Powell majority took a different path. It held that the gross estate should include two components: (1) the LP interest itself, at its discounted value, under §2033; and (2) the undiscounted value of the transferred assets under §2036(a), minus the discounted value of the LP interest the decedent received in exchange, under §2043(a). The court called the difference between the undiscounted asset value and the discounted LP interest value the “doughnut hole.”
The Math, on $10 Million
Here’s how it works in practice. Assume a 25% combined valuation discount (lack of control plus lack of marketability) on the LP interest, which is roughly what the Powell estate reported:
The decedent transfers $10 million in assets to the FLP and receives a 99% LP interest. After discounts, that LP interest is worth approximately $7.5 million. Under the Powell framework, the gross estate includes: the LP interest at its discounted value of $7.5 million (under §2033), plus the “doughnut hole” — the $10 million asset value minus the $7.5 million credit for the LP interest received (under §2036(a) as limited by §2043(a)), which equals $2.5 million. Total inclusion: $10 million. The same result as the traditional approach — if the assets haven’t appreciated.
But here’s where it gets consequential. If the assets appreciate between the contribution date and the date of death, the §2036(a) inclusion captures the appreciated value (because it includes the date-of-death value of the transferred assets), while the §2043(a) credit is frozen at the contribution-date value of the LP interest received. The doughnut hole gets bigger. The majority acknowledged this in a footnote: “duplicative transfer tax” would result from post-contribution appreciation. In Powell, Nancy died seven days later, so the parties stipulated that contribution values equaled date-of-death values and the issue was moot. For FLPs that hold appreciating assets for years, it’s not moot at all.
What This Means for Existing FLPs
If you have clients with FLPs formed before Powell, the case creates a review obligation. No appellate court has overruled Powell, and Tax Court judges have since cited it without retreat. The questions to work through:
Does the limited partner hold dissolution voting rights? Under most state partnership statutes and most LP agreements, limited partners can vote on dissolution. If the decedent, alone or in conjunction with family members, can dissolve the FLP, the §2036(a)(2) argument is live. Review the LP agreement and the applicable state statute. If dissolution requires unanimous consent of all partners and the partners include non-family members with genuine economic interests, the argument weakens considerably.
Is the bona fide sale exception available? This is the primary defense against §2036(a) inclusion, and it’s the one the Powell estate conceded. The exception requires (1) a legitimate and significant non-tax business purpose for the FLP’s creation and (2) that the transfer was for adequate and full consideration. If the FLP was formed primarily for estate tax reduction, holds only passive investments, and has no operating business or pooling of family assets from multiple contributors, the exception is at risk. Powell’s bad facts — deathbed formation, no business operations, single-contributor passive assets — represent the extreme, but the IRS routinely challenges FLPs with better facts on the same grounds.
Are fiduciary duties “illusory” in the family context? If the general partner is a family member (or an entity controlled by family members) and all partners are family, the court may find that fiduciary duties don’t meaningfully constrain the general partner’s discretion. Consider whether adding a non-family limited partner with a genuine economic interest — or appointing an independent party as general partner or as a distribution committee member — would change the analysis.
Is there post-contribution appreciation creating a duplicative transfer tax risk? If the FLP was funded with growth assets years ago and those assets have appreciated materially, the Powell doughnut-hole framework could result in an inclusion amount that exceeds the value of the assets at contribution — because the §2036(a) inclusion uses date-of-death values while the §2043(a) credit uses contribution-date values. This is the scenario the concurring judges warned about and the majority acknowledged in a footnote. Quantify the exposure.
When the FLP Still Works
Powell was a bad-facts case, and bad facts make bad law. But the case doesn’t eliminate FLP planning — it sharpens the requirements. An FLP that was formed well in advance of any health decline, that holds an active business or a genuine pooling of family assets from multiple contributors, that has a documented non-tax business purpose (asset protection, consolidated management, family governance), that observes entity formalities (books and records, regular meetings, actual distributions consistent with partnership terms), and that qualifies for the bona fide sale exception is not the FLP in Powell. The valuation discounts for a properly structured FLP remain available. The estate freeze benefits remain real.
The key is timing and substance. Clients who form FLPs in advance, fund them with assets that benefit from consolidated management, operate them as genuine business entities, and gift LP interests over time — rather than in a single deathbed transaction — remain on solid ground. If the FLP was created primarily to generate a valuation discount on a transfer that was going to happen anyway, Powell is a warning that the IRS has the tools to unwind it.
The Practical Takeaway
As of the date of this post, Powell is seven years old, and its most controversial holdings — §2036(a)(2) reaching limited partners, fiduciary duties deemed illusory in family FLPs, the doughnut-hole framework under §2043(a) — remain intact and unchallenged on appeal. The case hasn’t killed FLP planning, but it has made the margin for error much thinner. For T&E counsel, the immediate action item is a review of existing FLP structures against the Powell checklist: dissolution rights, bona fide sale exception, fiduciary duty independence, and post-contribution appreciation exposure. For clients considering new FLPs, the message is to build the non-tax business purpose and the operational substance first — not as an afterthought once the estate planning benefits are on the table.
If you’re reviewing existing FLP structures for §2036(a)(2) exposure or need a valuation of LP interests that accounts for the Powell framework, happy to talk through the analysis. Sometimes the control-structure review is more urgent than the valuation itself.
