Another Lesson on What Not To Do in FLLCs
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This is from the latest edition of the GiftLaw eNewsletter:
Note from Greg: Family Limited Partnerships (FLPs) were previously the preferred entity for obtaining discounts on transfers of wealth to younger family members. FLPs have largely been replaced by Family Limited Liability Companies (FLLCs). The writer of the article below often refers to FLPs even though the case involved FLLCs.
Indirect Gifts through FLP Trigger $1 Million Gift Tax
In David E. Heckerman et ux.v.United States; No. 2:08-cv-00211 (27 Jul 2009), the District Court determined that gifts of cash to an FLP together with gifts of FLP interests were indirect gifts valued at fair market value.
On November 28, 2001, David and Susan Heckerman created trusts for each of their two children, then ages five and two. They also created the Heckerman Family LLC and two solely-owned LLCs, Heckerman Investments LLC and Heckerman Real Estate LLC. Heckerman Investments LLC was designed to receive liquid securities and Heckerman Real Estate LLC was designed to hold realty.
On December 28, 2001, David and Susan Heckerman transferred a $2.05 million beach house in Malibu, California to Family LLC, with an immediate quitclaim deed to Real Estate LLC. On January 11, 2002, they transferred $2.85 million in mutual funds to Investments LLC and signed gift documents “effective on January 11, 2002” to transfer the majority of Family LLC units to the children’s trusts.
Appraiser Mark Wellington of Private Valuations, Inc. completed an appraisal of the value of Family LLC units gifted to the children’s trusts. He determined that the transfers would be subject to a 58% discount for lack of marketability. Therefore, both David and Susan had transferred a gift value of $1,022,000. Using their four annual exclusions (two parents times two children) and two $1 million gift exemptions, there was no gift tax payable.
The IRS audited the return, claimed that the securities transfer was an indirect gift and assessed gift tax of $511,497.56 for each donor. The Heckermans paid the gift tax and filed for a refund.
The IRS contended that under Reg. 25.2511-1(a), “whether the gift is direct or indirect,” there is a transfer. Because the transfer to the FLP was completed on the same date as the gift of the units and there was no clear evidence that the transfer of the FLP units was after the funding of the FLP, the IRS claimed that this was an indirect gift. The IRS also claimed a step transaction.
The court supported both positions by the IRS. First, the gifts of FLP interests were apparently not signed until after January 11, 2002, but were “effective as of January 11, 2002.” Therefore, the transfer process created an indirect gift on the theory that the children’s trusts owned the FLP units when the cash was transferred.
In addition, following the rationale of Senda v. Commissioner, 433 F.3d 1044 (8th Cir. 2006), there was a “step transaction” that also created the indirect gift. Because the transfer of $2.85 million in cash to Investments LLC and the gifts of the LLC units were an “integrated transaction,” the step transaction doctrine applied.
Editor’s Note: It is significant that the IRS did not object to the FLP discounts for the transfer of the real estate on December 28, 2001 and gift of FLP units two weeks later on Jan. 11, 2002. With even a period of two weeks between the funding and the FLP unit gifts, the transfer was effective in producing a substantial FLP discount.
