Linton v. U.S.: Indirect Gift of Property Owned by LLC

In a victory for the taxpayer, the Ninth Circuit Court of Appeals reversed the lower court’s grant of summary judgment in favor of the IRS.

The Lintons met with their attorney on January 22, 2003 to form, and transfer property to, a limited liability company (LLC). The Lintons also executed trust agreements for their children assigned interests in the newly formed LLC to the children’s trusts. These documents were left intentionally undated by the Lintons. At a later date, the Linton’s attorney dated the children’s trusts and the assignments January 22, 2003. He testified that this was a mistake and the Lintons intended for these documents to be dated January 31, 2003.

The Lintons filed a gift tax return reporting that the gift of the LLC interests to the children’s trusts occurred on January 31, 2003. The value of the gifted LLC interests were discounted for lack of control and marketability by 47% from the underlying value of the property held by the LLC.

The IRS argued that the transfer of assets to the LLC by the Lintons occurred contemporaneously with the gift of the LLC interests to the children’s trusts. Thus, the IRS claimed that the transfer of property to the LLC by the Lintons was an indirect gift of that property to the children’s trusts that was not entitled to any discount for lack of control and marketability.

The lower court agreed with the IRS and granted summary judgment. In addition, the lower court determined that even if the transfer of property to the LLC was not contemporaneous with the gift to the children’s trusts, the Lintons nevertheless made indirect gifts of that property to the children’s trusts under the step transaction doctrine (which treats separate but related steps as a single transaction). The Lintons appealed the lower court’s ruling to the Ninth Circuit Court of Appeals.

I. Timing of Transfers

The appellate court first reviewed whether the Lintons transferred assets to the LLC before the LLC interests were transferred to the children’s trusts. Under Washington state law, the determination of when the gifts to the children’s trusts were complete hinged on when the Lintons intended to make the gifts. The facts on record were conflicting. All of the documents were signed on the same day; however, the Lintons intentionally left the trusts and assignments undated. Because of the conflicting evidence, the case was remanded to the lower court to determine when the Lintons intended to make the gifts.

II. Step Transaction Doctrine

The appellate court also held that the lower court incorrectly applied the step transaction doctrine. The step transaction doctrine treats multiple transactions as a single transaction if at least one of three tests are satisfied:

1. the end result test;

2. the interdependence test; or

3. the binding commitment test.

a. End Result Test

The end result test asks whether a series of steps were undertaken to reach a particular result. The appellate court determined that the Lintons desired result was to transfer the LLC interests to the children’s trusts without giving them management control or ownership of the underlying assets. Thus, the Linton’s desired result was consistent with the tax treatment that they sought and the end result test was not satisfied.

b. Interdependence Test

The interdependence test asks whether the steps were so interdependent that the legal relations created by one transaction would have been fruitless without the completion of the other transactions. The court noted that placing assets into an LLC is a reasonable business activity even if the subsequent gifts to the children’s trusts were not made. Accordingly, the interdependence test was not met.

c. Binding Commitment Test

Finally, the binding commitment test asks whether, at the time the initial step of the transaction is made, there was a binding commitment to take the later steps. The binding commitment test only applies to transactions which span several years and, therefore, did not apply to this case.

III. Conclusion

Making gifts of LLC (or limited partnership) interests can be a very effective estate planning tool to transfer wealth as long as the transaction is properly structured. Although the Lintons may eventually prevail against the IRS, they could have saved themselves the stress (and attorney’s fees) of going to court by following these suggestions for gifting LLC (or limited partnership) interests:

1. Transfer property to the LLC before anyone else has an interest in the LLC;

2. Wait before making a gift of the LLC interest. The length of time to wait depends on the assets held by the LLC. Courts have looked to whether there was a real chance of a change in the value of the assets from the time they are contributed to the LLC to when the LLC interests are gifted. Thus, the more volatile the underlying assets, the less time that would be necessary to wait before a gift is made; and

3. Keep accurate records.

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