Wills and Trusts

Wyatt, Tarrant & Combs, LLP

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LP and LLC Interests As Present Interests

The issue of whether the gift of a limited partnership or limited liability company qualifies for the annual exclusion arose in Hackl v. Commissioner, 118 T.C. 279 (2002), affd. 335 F.3d 664 (7th Cir. 2003) with the lower court and Seventh Circuit deciding such interests were future interests because the interests received by the donees were restricted and the asset in the entity was a tree farm. In Price v. Commissioner, T.C. Memo, 2010-2, the Tax Court followed Hackl and, arguably, expanded its reach. The opinion focuses on the inability of the partners to compel distributions or to transfer the units.

It is undisputed that under the partnership agreement the donees have no unilateral right to withdraw their capital accounts. Furthermore, section 11.1 of the partnership agreement expressly prohibits partners from selling, assigning, or transferring their partnership interests to third parties or from otherwise encumbering or disposing of their partnership interests without the written consent of all partners. As stated with respect to analogous circumstances in Hackl v. Commissioner, 118 T.C. at 297, transfers subject to the contingency of approval (by the LLC manager in Hackl and by all partners in the instant cases) “cannot support a present interest characterization, and the possibility of making sales in violation thereof, to a transferee who would then have no right to become a member or to participate in the business, can hardly be seen as a sufficient source of substantial economic benefit.”

Moreover, because of the operation of section 11.2 of the partnership agreement, it appears that the donees are not even properly characterized as limited partners in the partnership.


But even if it were to be assumed, contrary to the foregoing analysis, that the donees did somehow become substituted limited partners, it would not affect our conclusion that contingencies stand between the donees and their receipt of economic value for the transferred partnership interests so as to negate finding that the donees have the immediate use, possession, or enjoyment of the transferred property. Pursuant to section 11.1 of the partnership agreement, unless all partners consented the donees could transfer their partnership interests only to another partner or to a partner’s trust. In addition, any such purchase would be subject to the option-to-purchase provisions of section 11.4 of the partnership agreement, which gives the partnership itself or any of the other partners a right to purchase the property according to a complicated valuation process but without providing any time limit for exercising the purchase option with respect to a voluntary transfer.


Because the partnership owned real properties generating rents under long-term leases, we believe that the partnership could be expected to generate income at or near the time of the gifts. The record fails to establish, however, that any ascertainable portion of the income would flow steadily to the donees. To the contrary, the record shows that the partnership’s income did not flow steadily to the donees–there were no distributions in 1997 or 2001.

Pursuant to the partnership agreement, profits of the partnership were distributed at the discretion of the general partner, except when otherwise directed by a majority in interest of all the partners, both limited and general. Furthermore, the partnership agreement stated that “annual or periodic distributions to the partners are secondary to the partnership’s primary purpose of achieving a reasonable, compounded rate of return, on a long-term basis, with respect to its investments.”

Petitioners allege that the partnership is expected to make distributions to cover the donees’ income tax liabilities arising from the partnership’s activities. Section 7.3 of the partnership agreement, however, clearly makes such distributions discretionary: “Neither the partnership nor the general partner shall have any obligation to distribute profits to enable the partners to pay taxes on the partnership’s profits.” Because the timing and amount of any distributions are matters of pure speculation, the donees acquired no present right to use, possess, or enjoy the income from the partnership interests.

Without citation of legal authority, petitioners contend that the general partner has a “strict fiduciary duty” to make income distributions to the donees. We are not persuaded that such a fiduciary duty, if it exists, establishes a present interest in a transferred limited partnership interest where the limited partner lacks withdrawal rights.10 Moreover, because (as previously discussed) the donees are not substituted limited partners, there is significant question as to whether under Nebraska law the general partner owes them any duty other than loyalty and due care.11 Cf. Kellis v. Ring, 155 Cal. Rptr. 297 (Ct. App. 1979) (holding that under California law the assignee of a limited partner’s partnership interest could not bring suit against the general partner for alleged breaches of fiduciary duty).

A common suggestion since Hackl has been that donees be given a put right to the donor. Although not squarely addressed by Judge Thornton the language of the opinion suggests that could be ineffective:

Petitioners allude to the possibility of the donees’ selling their partnership interests to the general partner. It must be remembered, however, that the general partner is owned by petitioners and that its president is Mr. Price, who engineered the gifts of partnership interests to his children in the first instance. If the possibility of a donor’s agreeing to buy back a gift sufficed to establish a present interest in the donee, little would remain of the present interest requirement and its statutory purpose would be subverted if not entirely defeated.

The same issue arose in district court in John W. Fisher et ux. v. United States, 105 A.F.T.R.2d 2010-1347 (S.D. Ind. March 11, 2010). There an LLC owned undeveloped land on Lake Michigan. The short opinion rejects the taxpayers’ claims of an annual exclusion:

The Fishers make three arguments in support of their assertion that the transfers of interests in Good Harbor to the Fisher Children were gifts of “present interests in property.” Treas. Reg. § 25.2503-3(b). The Court considers each in turn. First, the Fishers argue that upon transfer, the Fisher Children possessed the unrestricted right to receive distributions of Good Harbor’s Capital Proceeds. However, under the Operating Agreement, any potential distribution of Good Harbor’s Capital Proceeds to the Fisher Children was subject to a number of contingencies, all within the exclusive discretion of the General Manager. Operating Agreement §§ 4.2.3-.3.4. Accordingly, the right of the Fisher Children to receive distributions of Good Harbor’s Capital Proceeds, when such distributions occur, is not a right to a “substantial present economic benefit.” Hackl, 335 F.3d at 667; see Commissioner v. Disston, 325 U.S. 442, 449 (1945) (holding that when a trust provides for the distribution of the corpus or trust income only after some uncertain, future event, the trustee possesses a future interest.)

Second, the Fishers argue that upon transfer, the Fisher Children possessed the unrestricted right to possess, use, and enjoy Good Harbor’s primary asset, the Lake Michigan beach front property. See Pls.’ Br., Dkt. No. 33, at 9 (citing the affidavit of one of the Fisher Children, James A. Fisher). However, there is no indication from Good Harbor’s Operating Agreement that this right was transferred to the Fisher Children when they became “Member[s]”8 and “Interest Holder[s].”9 Regardless, the right to possess, use, and enjoy property, without more, is not a right to a “substantial present economic benefit.” Hackl, 335 F.3d at 667. It is a right to a non-pecuniary benefit.

Lastly, the Fishers assert that upon transfer, the Fisher Children possessed the unrestricted right to unilaterally transfer their interests in Good Harbor. The Fishers argue that this right is a present interest in property. Cf. Hackl, 335 F.3d at 667-68 (holding that the Hackls’ gifts were not gifts of present interests, because “Treeco’s restrictions on the transferability of the shares meant that they were essentially without immediate value to the donees.”).

Under Section 6.1, the Fisher Children may unilaterally transfer their right to receive distributions from Good Harbor, but only if certain conditions of transfer are satisfied. Operating Agreement § 6.1.1-6.1.5. Among these conditions is Good Harbor’s right of first refusal, which effectively prevents the Fisher Children from transferring their interests in exchange for immediate value, unless the transfer is to one of the Fisher’s descendants (a “family member”). Id. § 6.1.4-6.1.5. Even an attempted transfer to a family member is not without restrictions. Id. §§ 6.1-, 6.1.5. Therefore, due to the conditions restricting the Fisher Children’s right to transfer their interests in Good Harbor, it is impossible for the Fisher Children to presently realize a substantial economic benefit. Cf. Wooley v. U.S., 736 F.Supp. 1506, 1509 (S.D. Ind. 1990) (Dillin, J.) (holding that Wooley’s gifts to his partners’ capital accounts were gifts of present interests, because “each partner had the unrestricted and immediate right to withdraw [the] gifts. . . .”).

The Tax Court reached the contrary conclusion in Estate of George H. Wimmer et al. v. Commissioner, T.C. Memo. 2012-157 (2012). There the partnerships were initially created in California but moved, in 1997, to Georgia, and owned marketable securities. The transfers at issue were made in 1996-2000. The court noted that the partnership would receive income and thus the partners would owe income tax. Under California and Georgia law, unmodified by the partnership agreement, the general partner had a fiduciary duty to distribute tax liability amounts to the partners. The opinion states:

In describing the general partners’ powers, the partnership agreement, as initially written and as restated, provided that the general partners “possess full and exclusive power to manage, control, administer and operate Partnership business and affairs * * * subject, in all events, to fiduciary duties to Limited Partners and the continuing duty to advance the Partnership’s purposes and best interests”. Under California law, partners have fiduciary duties toward each other and because of such duties may not take advantage of, or otherwise put adverse pressure on, other partners when conducting partnership business. See, e.g., Leff v. Gunter, 658 P.2d 740, 744 (Cal. 1983); BT-I v. Equitable Life Assurance Soc’y, 89 Cal. Rptr. 2d 811, 815-816 (Ct. App. 1999) (citing Cal. Corp. Code sec. 15643 (West 1991) (repealed 2006)). In Georgia, general partners owe fiduciary duties to limited partners, including the duty to act in the utmost good faith and with the finest loyalty, which the limited partners are entitled to enforce. See, e.g., Hendry v. Wells, 650 S.E.2d 338, 346 & n.9 (Ga. Ct. App. 2007).

According to the Grandchildren Trust documents, the trust’s only asset was a limited partnership interest, which, given the transfer restrictions described above, could not be liquidated or otherwise exchanged for cash. Notably, the partnership’s sole asset was dividend-paying stock.9 As a limited partner, and on behalf of the Grandchildren Trust, the trustee was allocated its proportionate share of the dividends paid each year. Because the Grandchildren Trust had no other source of income, distributions of partnership income to the trustee were necessary to satisfy the Grandchildren Trust’s annual Federal income tax liabilities. The Court holds that the necessity of a partnership distribution in these circumstances comes within the purview of the fiduciary duties imposed on the general partners. Therefore, the general partners were obligated to distribute a portion of partnership income each year to the trustee.

The partnership agreement provided that after allocating partnership net profits and losses, and every item of income, gain, loss, deduction, and credit proportionately among the partners in accordance with their respective percentage interests consistent with section 704, distributions of net cash flow shall be made to the partners in proportion to their respective percentage interests. Because distributions must be pro rata, any distribution to the trustee triggered proportionate distributions to the other partners. The estate has thus proven that, on the date of each gift, some portion of partnership income was expected to flow steadily to the limited partners. Indeed, the record shows that the partnership made distributions pro rata from dividends paid each year at issue.10

Finally, the Court holds that, with respect to the third prong, the portion of income flowing to the limited partners could be readily ascertained. The partnership held publicly traded, dividend-paying stock and was thus expected to earn dividend income each year at issue. Because the stock was publicly traded, the limited partners could estimate their allocation of quarterly dividends on the basis of the stock’s dividend history and their percentage ownership in the partnership.

Footnote 10 is as follows:

The Court notes that, unlike the taxpayers in Hackl and Price, decedent, in his fiduciary capacity as general partner of the partnership, made distributions each year at issue and was required to do so. See Hackl v. Commissioner, 118 T.C. 279, 298 (2002), aff’d, 335 F.3d 664 (7th Cir. 2003); Price v. Commissioner, T.C. Memo. 2010-2.

Wimmer suggests that limited partnership gifts have certain advantages over LLC unit gifts. The effect of a present interest requirement, if any, on charitable gifts ought be considered too.

Turney P. Berry
Louisville, Kentucky


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LLC Interest Value as Membership Interest Not Assignee Interest

The Estate of Diane Tanenblatt et al. v. Commissioner, T.C. Memo. 2013-263, involved two valuation issues. First, the taxpayer argued that the willing buyer-willing seller test must assume a non-family member purchaser who would not be admitted to the LLC as a member. The IRS disagreed and Judge Halpern agreed with the IRS, holding:

We must determine whether respondent and Mr. Thomson [government appraiser] erred in classifying the subject interest as a member’s interest rather than classifying it as an assignee’s interest. A member’s interest is more valuable than an equivalent percentage interest of an assignee because the member’s interest can participate in management and control of the LLC. We think respondent and Mr. Thomson did not err. Decedent was a member of the LLC when she transferred the subject interest to the trust. We assume, therefore, that, until she made the transfer, she enjoyed all of the benefits and was saddled with all of the burdens attendant upon being a “member” of the LLC. The term “member’s interest” (or the term “membership interest”, which the parties use, but which we do not, because it is a term defined in the operating agreement to mean a member’s proportional interest in capital) is both a convenient and an accurate classification for indicating that decedent’s interest in the LLC was of the fullest kind; i.e., she shared in management and control and did not merely share in profits and losses. For the same reasons, the term is a convenient and accurate classification for the subject interest in the hands of the trust, which also was a member of the LLC. Moreover, there is no evidence that, on or before the valuation date, the trust distributed, sold, exchanged, or otherwise disposed of the subject interest, so that, possibly, on that date, it could more accurately be described as an assignee’s interest. Therefore, because the term “member’s interest” conveniently and accurately describes the rights inherent to a subject interest on the date decedent transferred it, on the date she died, and on the valuation date, neither respondent nor Mr. Thomson erred in classifying it as such (or, in their terms, classifying it as a “membership interest”).

* * *

Certainly, in applying the willing buyer-willing seller standard to determine the value of the subject interest, it would be appropriate to take into consideration limitations in the operating agreement on the rights of a nonfamily member transferee to participate in control and management of the LLC and limitations on the transferee’s rights otherwise to be treated as a member. Petitioner, however, seeks to collapse the two steps of the valuation process — i.e., (1) identify the property to be valued and its nature and character, and (2) objectively determine its value — into a single step. Petitioner would expand section 20.2031-1(b), Estate Tax Regs., beyond its intended scope by using the provision to redefine the character of the subject interest as an assignee’s interest. See Kerr v. Commissioner, 113 T.C. 449, 469 (1999), aff’d, 292 F.3d (5th Cir. 2002). As discussed in the immediately preceding paragraph of this report, on the valuation date the subject interest was a member’s interest. The holder of that interest, at that time, enjoyed fully the benefits and burdens of being a member of the LLC, including his or her inability to transfer all of those benefits and burdens to a nonfamily member transferee. The hypothetical willing buyer and hypothetical willing seller — “both having reasonable knowledge of relevant facts”, sec. 20.2031-1(b), Estate Tax Regs. — would understand a member’s interest to be so restricted, and would take that restriction into account in their negotiations of what a member’s interest was worth. Mr. Thomson considered restrictions imposed on transferability of an interest in the LLC as a factor in his marketability discount analysis.

The taxpayer filed with its Tax Court petition a new appraisal which was lower than the appraisal submitted with the Form 706. The Tax Court was asked to consider the new appraisal in an unusual procedural move. A relevant factor for the new appraisal may have been a fee dispute with the original appraiser. The opinion states:

Before trial, petitioner untimely moved to compel respondent to stipulate either the Tindall appraisal or, alternatively, the entire petition (including the attached Tindall appraisal). Petitioner alternatively moved to sanction respondent for failing to so stipulate. We denied petitioner’s pretrial motions and proceeded to hold trial. The parties have stipulated copies of the petition and the answer, which are attachments to the stipulation, and have stipulated separately the text of the averment. They did so subject to the caveat that the stipulations “show the parties’ pleadings in this case and are not admitted in evidence.” Petitioner asks that we reconsider our prior rulings with respect to the Tindall appraisal or otherwise allow it into evidence and consider it expert testimony.

Petitioner’s path for attempting to introduce the Tindall appraisal into evidence as expert testimony is, to say the least, unusual. Generally, a party obtains the testimony of an expert witness by calling that witness to testify. See Rule 143(g)(1). Pursuant to that Rule, the expert witness must prepare a written report, which is marked as an exhibit and, after having been identified by the witness and adopted by him, received into evidence as his direct testimony unless the Court determines that the witness is not qualified as an expert. The Rule [*11] further provides that, not less than 30 days before the call of the trial calendar on which a case appears, a party calling an expert witness shall serve on each other party and submit to the Court a copy of the expert’s report. Finally, the Rule also provides that, generally, we will exclude an expert witness’ testimony altogether for failure to comply with the Rule. Those requirements are echoed in our standing pretrial order, which was served on petitioner.

Petitioner’s chosen means for seeking to introduce the Tindall appraisal into evidence is perhaps explained by a conversation we had with his counsel at the hearing during which we considered petitioner’s pretrial motions along with respondent’s motion in limine to exclude the Tindall appraisal on various grounds, including that petitioner had not submitted and served a copy of the report as required by Rule 143(g)(1) and our standing pretrial order. Petitioner had filed no response to respondent’s motion in limine, and, at the hearing, in response to the Court’s question as to whether petitioner was just relying on his own motions (with respect to stipulating the Tindall appraisal into evidence), petitioner’s counsel candidly responded: “Probably. Your honor, because right now my client’s in a fee dispute with the appraiser, so right now I cannot get the appraiser to come in and testify.” Apparently, counsel’s time is less dear than was Dr. Tindall’s.

The court refused to consider the Tindall appraisal:

Petitioner did not call Dr. Tindall as a witness but asks us to rely on her report (which, under our Rules, would serve as her direct testimony) as her expert opinion. Petitioner has neither qualified Dr. Tindall as an expert entitled pursuant to rule 702 of the Federal Rules of Evidence to give her opinion on technical matters nor has he satisfied our procedural rules for expert testimony, found in Rule 143(g) and in our standing pretrial order. In other words, petitioner has failed to satisfy the preconditions for our receiving Dr. Tindall’s opinion into evidence. Because her report (i.e., the Tindall appraisal) is not in evidence, we may not consider her opinion.

The gap between the government’s position and the Form 706 filing was not enormous. Each began with the same underlying value for a New York City office building owned by the LLC. The transferred interest was 16.67%. The taxpayer’s Form 706 appraiser took a 20% lack of control discount and a 35% discount for lack of marketability. The government expert reduced those to 10% and 20%. The increase in the value of the estate was $687,882.

Turney P. Berry
Louisville, Kentucky