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Buchanan Law Group September 22, 2009


Hello, [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).
Factual Background 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 for 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 LLC are 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. §301.7701-3(a). 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. Sincerely,
Robert Buchanan Buchanan Law Group
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