Indirect Gift Principle.
Under Treasury Regulation Sec. twenty five.2511-one(h)(one), if anyone will make a money contribution to a company, it outcomes in an oblique gift of the house to each shareholder of the company in proportion to this sort of shareholder’s stockholdings. In the context of LLCs and FLPs, an oblique gift may perhaps come about if the taxpayer can not confirm that the transfer of belongings to the LLC/FLP occurred just before the assignment of the LLC/FLP pursuits to the donees. And when the transfer of belongings and gift of pursuits in the LLC/FLP are created on the similar day, it’s challenging for the taxpayer (who has the stress of proof) to confirm which transpired to start with.
The action-transaction doctrine treats a sequence of separate ways as a one transaction if this sort of ways are in material built-in, independent and focused toward a specific final result. Applying this doctrine to LLCs and FLPs, if the funding of the entity and the gifts of pursuits were being collapsed into a one transaction, the final result is a gift of the entity’s fundamental belongings (as opposed to gifts of membership / partnership pursuits). As this sort of, there would be no valuation special discounts.
In common, the scenarios working with the action-transaction doctrine do not provide the magical timeframe needed amongst the funding of the entity and the gifting of the company pursuits, but they do expose two styles. 1st, simultaneous funding and gifting is a obvious indicator of an built-in transaction that will induce the action-transaction doctrine. Second, the volatility of the asset is product to the examination of irrespective of whether adequate time lapsed amongst the funding and the gifting. In other text, the taxpayer have to exhibit that he/she bore serious financial chance that the pursuits transferred would alter in value amongst the funding and the gifting.
Summary of the Situations.
In Gross v Comm’r, T.C. Memo 2008-21, the taxpayer’s delay of eleven (11) times amongst funding and gifting was sufficient to disarm the action-transaction doctrine provided the specific belongings at difficulty (i.e. volatile marketable securities).
In Holman v Comm’r, a hundred thirty T.C. one hundred seventy, 2008, a further case in which the fundamental belongings were being marketable securities, a delay of 6 (6) times averted the action-transaction doctrine.
In Linton v U.S., 104 AFTR 2d 2009-5176 (W.D. Washington, July one, 2009), there was no concrete proof that the funding and gifting did not come about on the similar day, in spite of the taxpayer’s declare that 9 (9) times lapsed amongst funding and gifting. Even so, the Court docket dominated in favor of the govt due to the fact the belongings at difficulty (income, municipal bonds and serious estate) were being not considered adequately volatile that the taxpayer bore any serious financial chance for the duration of claimed 9-day period.
In Heckerman v U.S., U.S. Dist. Ct. W.D. Washington, Circumstance No. 008-0211-JOC (July 27, 2009), the taxpayer transferred liquid belongings to an LLC and created gifts of the LLC pursuits to trusts on the similar day. The Court docket dominated that the transfer of the liquid belongings was an oblique gift (due to the fact the taxpayer could not confirm any delay occurred amongst funding and gifting). The Court docket also dominated that the action-transaction doctrine utilized due to the fact there was no “serious financial chance” included. On the other hand, the IRS did not problem the valuation special discounts in a second transaction involving gifts of LLC pursuits in serious estate in which there was a delay of fifteen (15) times amongst funding and gifting.
When working with fewer volatile belongings, the trouble lies in proving that a “serious financial chance” exists. But, in Heckerman the IRS chose not to make the oblique gift or action-transaction arguments with respect to a 15-day delay involving an LLC possessing serious estate (an arguably non-volatile asset). So we will have to see how the IRS handles related transfers in the potential.
It will also be exciting to see what other courts do with the oblique gift theory and the action-transaction doctrine. Regardless of individuals arguments, the base line is that the donee finishes up holding membership / partnership pursuits (with significant restrictions below the operating / partnership agreements) – and not the entity’s fundamental belongings.
Lastly, the Court docket in Heckerman implied that a non-tax intent may perhaps be sufficient to stay clear of the application of the action-transaction doctrine. The “non-tax intent” argument has so much been restricted to estate tax scenarios below IRC Area 2036 (transfers with a retained desire). Now it may perhaps become relevant in gift tax scenarios as properly if the IRS continues to drive its action-transaction and oblique gift arguments.
The original contributions created to an LLC or FLP should really be documented equally in the Operating / Partnership Agreement and on the entity’s books and records. If extra contributions are created, they should really maximize the proportion pursuits owned by the contributing member / spouse and be credited contemporaneously to that member’s / partner’s money account.
In addition, put as a lot time as possible amongst the funding of the LLC or FLP and the gifting of the membership / partnership pursuits. The fewer volatile the asset (i.e. serious estate and liquid belongings) the much more time needed.
Lastly, document the non-tax applications of the proposed transaction.
By subsequent these ways, you should really be equipped to defend an attack by the IRS below both the oblique gift theory or the action-transaction doctrine.
THIS Posting May possibly NOT BE Utilized FOR PENALTY Defense. THE Material IS Primarily based On Basic TAX Policies AND FOR Details Needs ONLY. IT IS NOT Supposed AS Lawful OR TAX Suggestions AND TAXPAYERS Should really Seek the advice of THEIR Possess Lawful AND TAX ADVISORS AS TO THEIR Certain Scenario.