Appeals Court Reversal May Provide Discounts for Gifts of Family LLC Interests
Appeals court reverses trial court decision that disallowed discounts for gifts of family limited liability company membership interests.
Linton, William A. v. U.S., (CA 9 1/21/2011)
The Court of Appeals for the Ninth Circuit has reversed a district court’s grant of summary judgment in favor of the government. The district court held that the donors’ transfer of real estate, cash, and securities (the bulk of which were municipal bonds) to a family limited liability company (“FLLC”) in which trusts for the donors’ children were given interests in the FLLC were not gifts of FLLC interest to the trusts, rather the transfers to these trusts were considered indirect gifts of pro rata shares of the assets transferred to the FLLC.
Since the court of appeals reversed the district court’s finding that the property contributions to the FLLC occurred after the transfer of the FLLC interests to the children’s trusts, the case was sent back to the district court to reexamine this issue. Under the district court’s holding, no discount was allowable for transfer restrictions imposed by the FLLC operating agreement. As a result of the reversal and remand, the district court will determine whether the contributions to the FLLC occurred before the transfers of the FLLC interests to the children’s trusts. If the contributions are deemed to have occurred before the transfers, the value of the FLLC interests might be discountable for gift tax purposes.
Transactional Facts. On their gift tax return, donors William and Stacy Linton reported that they had made gifts of interests in an FLLC, and they claimed a 47% discount because the FLLC operating agreement imposed limitations on transfers to non-family members and gave the donors the sole authority to act for the FLLC.
The documents evidencing the contribution of property to the FLLC, creating a trust for each child, and giving each trust a percentage interest in the FLLC were all signed and dated January 22, 2003. However, the attorney who had prepared the documents testified that the reason the documents were all dated the same day was that a few months after the transactions were complete, when he was preparing the minute book for the FLLC, he noticed that the trust agreements and the gift documents were not dated. The attorney subsequently filled in the date of January 22, 2003 on each document. The attorney further testified that he later realized he had made a mistake in dating all the documents January 22, 2003, and that the intended date for the creation of the trusts and the transfers of interests in the FLLC to the trusts was January 31, 2003 (i.e., several days after the donors had contributed property to the FLLC).
At trial, the IRS argued that no discount was allowable because the Lintons had not made gifts of FLLC interests, but had made indirect gifts of the underlying property they had contributed to the FLLC.
The trial court agreed with the IRS, and found that the attorney’s testimony regarding the dating of the trust agreements was insufficient to prove the sequence of events the donors asserted. The court emphasized that each trust agreement provided that it was effective upon contribution of property to the trust and that, at the time of the trust agreement’s signing, property consisting of interests in the FLLC had been transferred to the trustee. Thus, the trial court found that the express language of the documents established that the trusts were created and the gifts were made on January 22, 2003. Because the trusts were created and gifts of FLLC interests were made to the trusts on January 22, 2003—either before, or simultaneously with, the contribution of property to the FLLC—the trial court determined that the Lintons’ transfers enhanced the FLLC interests held by the children’s trusts, thereby constituting indirect gifts to the trusts.
Ninth Circuit’s View. The Appeals Court determined that the trial court will be required to determine when the Lintons donated the FLLC interests to their children’s trusts – did they do so before they funded the FLLC (in which case the Lintons would potentially be liable for the full value of the assets conferred, as an indirect gift, to their children), or was it after they funded the FLLC (in which case the Lintons would be entitled to marketability and minority discounts on the assets transferred)?
Recommendations. While the Lintons may ultimately prevail, donors in these types of situations should take appropriate precautions in order to avoid being involved in subsequent litigation. To that end, a donor should take these steps to help assure that a transfer of property to an FLLC, and a transfer of an ownership interest in the FLLC, will not be challenged as an indirect gift of the FLLC’s underlying property.
1.The donor should transfer property to the FLLC before other family members are given interests in the FLLC or when the other family members’ ownership interests in the FLLC are small.
After creating and funding the FLLC, the donor should wait a reasonable period of time before making gifts of FLLC interests to the family members.
The donor should keep meticulous records documenting the date each transaction is completed.
Following the above steps should help donors achieve lack of control and marketability discounts for the transferred FLLC interests, while at the same time preventing the donor from being charged with indirect gifts of the full fair market value of the property transferred to the FLLC. The same approach can be applied for transfers to family limited partnerships.