Gifting LLC Interests to Family Members—Timing Is Everything
Limited Liability Companies (LLCs) and Family Limited Partnerships (FLPs) have been useful wealth transfer and estate planning tools for many years. For example, if an estate planning client has a goal of transferring assets and wealth to a son, daughter or grandchild at the least gift-tax cost, one tool to accomplish this goal is to form an LLC or FLP, contribute assets to it and then gift LLC or FLP interests either outright or in trust.
Gifts of LLC or FLP interests are generally easier to make than gifts of most other types of assets (e.g., fractional interests in real estate). More importantly, gifts of LLC and FLP interests will generally be valued at lower amounts because appraisers will apply discounts for lack of control and lack of marketability. These discounts vary, but they can, in some cases, exceed 40% of the value of the underlying LLC or FLP assets. By using the LLC or FLP estate planning technique, the client can achieve his or her goal of transferring assets and wealth to family members at a very low gift-tax cost.
But Caution Must Be Exercised
The Internal Revenue Service (IRS) has never liked discounts and has attempted to attack these transactions under various theories over the years—with varying success. Recently, the IRS was successful in attacking discounts taken in two LLC cases viz: Liton v. United States, No. 2:08-cv-00227 (W.D. Wash. July 1, 2009) and Heckerman v. U.S., U.S. Dist. Ct., W.D. Washington, Cause No. C08-0211-JCC (July 27, 2009). In both cases, LLCs were formed with the goal of making discounted gifts to family members. In both cases, the IRS was successful in attacking discounts under two theories: 1) the indirect gift theory and 2) the step transaction theory.
The IRS argued that the client did not gift LLC interests at discounted values to family members, but instead made gifts of the underlying assets of the LLC at full value. In Liton the discount claimed was 47%; in Heckerman it was 58%. The court held that no discounts were allowed because the LLC was funded with assets on the same day that gifts of LLC interests were made to family members. Because there was no gap in time between the funding of the LLC and the gifting of the LLC interests, the court held that the taxpayer suffered "no real economic risk," and that the formation, funding and gifting of LLC interests was all part of one integrated transaction entered into for the sole purpose of minimizing gift taxes.
The court did, however, cite and distinguish two other recent cases with similar facts but having different results, viz: Holman v. Commissioner, 130 T.C. 12 (2008) and Gross v. Commissioner, 96 T.C.M. 187 (2008) [TC Memo 2008-221] WL 4388277 (2008). The court said that Gross and Holman were distinguishable from Liton and Heckerman because there was a sufficient gap in time between funding of the LLC and gifting the LLC interests to family members. In Holman the time delay was six days, and the asset transferred to the LLC was Dell stock. In Gross the time delay was 11 days, and the asset transferred to the LLC was again marketable securities.
One interesting aspect about Liton and Heckerman is that one of the assets transferred to the LLC was real estate—not the most volatile asset. The Court noted that even a time delay between funding of the LLC and gifting of LLC interests will not necessarily avoid application of the step transaction doctrine, and that the acceptable length of time between the funding of the LLC and the gifting of the LLC interests may ultimately turn and depend on the type of asset used to fund the LLC.
Estate Planning Suggestion
Adhere to the "30-, 60-, 90-day rule."1 Have at least a 30-day gap between the funding of the LLC and the gifting of LLC interests if most of the underlying LLC assets consist of marketable securities. Have a 60-day gap if most of the underlying assets are bonds or other similar, less volatile assets. And finally, have a 90-day gap if most of the assets consist of real estate. When in doubt, use the 90-day rule. This rule should in most cases avoid a successful attack by the IRS under either the indirect gift theory or the step transaction theory.