Buchanan Law Group
September 22, 2009
[Our apologies. We are
sending this Law Note out again, because the version sent last week mistakenly
used an old title from a previous template. The body, below, is the same as the
version of this Law Note sent last week under the banner "California Appellate
Court Strikes Down Provisions In Injunction Prohibiting Solicitation by Former
Employees", which had been the topic and substance of the previous Law Note. We
apologize for the confusion].
The estate and gift tax
planning landscape in recent years has been pocked with defeats as the IRS
continues its attempts to frustrate taxpayers' desires to decrease the size of
their taxable estates by gifting away assets during their lifetimes in the form
of partial interests in family limited partnerships (FLIPs) or family limited
liability companies (FLLCs). The
taxpayer won a victory recently when the U.S. Tax Court held that transfers of
interests in a single-member FLLC (i.e., a family limited liability company with
just one member), were to be valued for gift tax purposes as transfers of
interests in the LLC. The IRS had argued
that since under the check-the-box regulations the FLLC was treated as a
disregarded entity for general tax purposes, it followed that a gift of an
interest in the FLLC should be treated as a direct gift in the assets owned by
the LLC, thus negating the valuation discounts for lack of marketability and
control the taxpayer had taken. As a
result of the taxpayer-friendly ruling, there was no look-through, and the
gifts were respected as gifts of LLC units. SeeSuzanne Pierre, 133 T.C. 2 (2009).
After receiving $10
million from a wealthy friend, Suzanne Pierre transferred cash and publicly
traded stock to a limited liability company she created under New York Law -
the Pierre Family. In exchange, she
received 100% of the interests in LLC. She had also established individual trusts
her son and granddaughter, and then transferred as a gift a 9.5% interest in
LLC to each trust. She also sold a 40.5%
interest in the LLC to each trust in exchange for a promissory note. In valuing
the transfers for Federal gift tax
purposes, she applied substantial discounts for lack of marketability and
control and so paid no gift tax on the transfers.
The Check-the-Box Regulations
Under the "check-the-box"
system of classifying entities for income tax purposes, single-owner eligible
entities may elect to be classified as corporations, or may choose to have
their status as entities separate from their owners ignored. Treas. Reg. §301.7701-3(a).
A single member LLC that doesn't elect to be
treated as a corporation under the check-the-box regulations is considered a
disregarded entity for federal tax purposes. The activities of a single member
treated in the same manner as a sole proprietorship - the entity being ignored
and its property and activities being treated as those of the owner of the
entity. SeeTreas. Reg.
The IRS Position
A gift for Federal gift
tax purposes, and the resulting gift tax, are generally based on three things:
what the property interest is, what it's value is, and the calculation of the
federal income tax due. With respect to
what the property interest is, it is the determination under State law of the
property interest that the donor transferred which is the focal point. In assessing
a deficiency, the IRS argued
that the transfers should be treated as transfers of the underlying assets of
LLC because a single-member limited liability company is a disregarded entity
under the check-the-box regulations. Thus, IRS contended that Pierre made gifts
equal to the total value of
the assets of LLC, less the value of the promissory notes she received from the
trusts. This position would not have
permitted her to avail of the substantial discounts in the LLC interest she had
taken, which an integral part of her gifting strategy.
The Tax Court's Holding
The Tax Court determined that under New
York law (BLG: as with California
law) Ms. Pierre did not have a property interest in the underlying assets of the
LLC. Under the New York statute, the LLC was recognized as
an entity separate and distinct from its members. Federal tax law was immaterial.
There simply was no State law property interest
in those assets for Federal income tax law to designate as taxable, and Federal
law couldn't create a property right in those assets. Ms. Pierre's gift tax liability
was thus determined
by the value of the interests transferred in LLC, not by a hypothetical
transfer of the LLC's underlying assets.
Though this decision is
indeed a victory for taxpayers seeking to use single member LLCs in gifting
strategies, the victory here may be Pyrrhic, as the Court suggested it would
rule on the validity of the valuation discounts in a separate ruling. Stay tuned
on that front. To read the entire opinion, you can cut and
paste this link into your browser: http://www.ustaxcourt.gov/InOpHistoric/pierre.TC.WPD.pdf.
This case and others demonstrate
how careful one must be to ensure an effective estate reduction gift tax
strategy. The current climate of
uncertainty, with a current estate tax exemption of $3.5 million, and no estate
tax in 2010, makes careful planning even more challenging and important. If you
have any questions concerning your own
family or estate planning, please give us a call.
Buchanan Law Group
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