On January 18, 2000, the U.S. District Court for the Western District of Texas issued an opinion in the first limited partnership case to be tried in federal court. The opinion resulted from a bench trial. Plaintiff had prayed for a refund of estate taxes they argued were wrongfully assessed and collected. This victory for the taxpayer provides us with an interesting fact pattern and judicial treatment of them.


On October 22, 1993, Elsie Church and her two children, Marshall Miller and Mary Elsie Newton, executed an agreement that resulted in the formation of the Stumberg Ranch Partners Ltd. under Texas limited partnership law. On October 24, 1993, Elsie Church died suddenly of cardiopulmonary collapse. On October 26, 1993, the Certificate of Limited Partnership was filed with the Office of the Texas Secretary of State.

On July 25, 1994, the Estate of Elsie Church filed its return, valuing her limited partnership interest at $617 thousand. The IRS served a notice of deficiency of $212 thousand, plus interest. On April 8, 1996, the Estate paid a total of $230 thousand. On June 26, 1997, the Estate filed a lawsuit seeking a refund of this payment after the IRS denied its claim earlier in the year.

The Stumberg Ranch Partners Ltd. (the “Partnership” or “Stumberg”) was formed for two purposes. First, the partners wanted to consolidate their undivided interests in a family ranch in order to centrally manage their interests and preserve the ranch as an ongoing enterprise. Mrs. Church’s two children actively managed the ranching operation. Second, Mrs. Church wanted to protect her assets against creditors in the event of a catastrophic tort claim against her. Mrs. Church and each of her children were limited partners. The general partner was designated as Stumberg Ranch L.C. and was to be owned by Marshall and Newton equally. This entity was not formed when the agreement was signed.

Capital contributions to the Partnership consisted of each limited partner’s undivided interest in the ranch and $1 million in marketable securities held by Mrs. Church in a Paine Webber account. The undisputed value of the interest in the Ranch contributed by Mrs. Church was $380 thousand, while her children’s interests were $233 thousand.

The partnership agreement allocated profits or losses from the ranch operations in proportion to the interests contributed by the partners. Ninety-nine percent of the taxable income from securities was allocated to Mrs. Church. Essentially, Stumberg was a pro rata partnership because profits, losses and income were allocated in proportion to each partner’s capital contribution.


At trial, the government advanced several arguments in support of their denial of a refund of estate taxes. Defendants argued that the partnership was not valid because the paperwork was not complete at the time of death and was formed in contemplation of Mrs. Church’s death. The court disagreed because medical facts indicate there was no contemplation of death. In addition, the court cited the fact that all the paperwork was not completed on the date of formation as an indication that no one involved had considered the potential for Mrs. Church’s death.

The government argued that the partnership was formed solely to reduce Mrs. Church’s taxable estate. The court disagreed. The court recognized that the partnership was formed for two valid reasons. First, it was formed to consolidate the family’s interest in the family ranch to provide for centralized management and to preserve the ranch as an on-going enterprise for future generations. Facts were introduced at trial indicating there had been difficulty with another owner of an undivided interest who had interfered with the ranch’s operation. In addition, the Partnership was formed to protect Mrs. Church’s assets from judgment creditors in the event of a tort claim against her.

The government suggested that the Partnership was simply a means of transferring property to family members for less than full consideration. The government contended the difference between the fair market value of the assets Mrs. Church contributed to the Partnership, $1.5 million, and the value of her Partnership interest, $617 thousand, should be taxed as a gift. The court rejected this argument, indicating that Mrs. Church received a partnership interest proportional to the contributions and partnership interests of the other partners and there was no evidence that anyone experienced a financial benefit or increase in wealth.

The government argued that the securities held in a Paine Webber account, valued at $1.4 million were not conveyed to the partnership since her name, rather than that of the Partnership, was on the account several months after formation of the Partnership. Therefore, the estate should be taxed on their $1.4 million value. The court disagreed, stating that well established law directs judicial attention to intent of the parties when determining ownership of property, not legal title.

Finally, the government argued that the valuation of the partnership interest should not consider restrictions on sale contained in the partnership agreement, which reduce their value. The court rejected this indicating that there is nothing in the legislative history of the estate tax suggesting Congress wanted to address restrictions on sale/assignment of partnership interests. Rather Congress (sec. 2703) indicated that rights and restrictions like below-market buy sell agreements and options that artificially depress the FMV of the taxable property should be disregarded because they are not inherent components of the property itself.


Rejecting all the arguments put forth by the government, the court granted the estate a full refund based on the value advanced by its expert. The government never presented an alternate valuation opinion.

This case is interesting because the taxpayer scored a complete victory. In the present case, none of the government’s arguments regarding the validity of the partnership or the appropriate taxation of the partnership interests were accepted. The facts of the case supported the conclusion that the limited partnership was a valid entity. However, readers should be cautioned that judicial acceptance of this partnership does not mean any limited partnership will be accepted for estate tax purposes. That determination is very fact specific.

In addition, it should be noted that part of the reason this opinion might be characterized as a “taxpayer victory” resulted from the absence of a “battle of the experts”. Many times, it seems that judicial opinions seem to “split the baby” when determining the value of a business interest between various expert opinions. The estate received its full prayer for relief in this case because the government offered no alternative valuation.

Reprinted from Mercer Capital’s BizVal.com  – Vol. 12, No. 2, 2000.

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