|April 13, 2010|
Previously published on April 2010
Section 2503(b) of the Internal Revenue Code allows an individual to give an unlimited number of donees a certain amount as a gift each year without incurring liability for gift taxes and without using any of the donor’s lifetime exemption. This annual exclusion amount is set by the Code at $10,000 per donee, but this number is inflation adjusted and is $13,000 for this year. In order to qualify for the annual exclusion, the gift must be of a present interest in property. This means that gifts to a trust generally do not qualify although there is an exception created by a court case called Crummey. If the trust contains a provision allowing the trust beneficiary to withdraw the amount of the gift for a period of time (usually 30 days) then it is considered to be a present interest and the exclusion is applicable.
In two recent cases, the Tax Court and a United States District Court both held that gifts of interests in family limited partnerships did not qualify as gifts of present interests. In Walter M. Price v. Commissioner, decided by the Tax Court in January, the court followed its holding in a 2002 case called Hackl v. Commissioner. That case held that interests in a limited liability company were not present interests. The court decided that the gifts in Price were not present interest gifts because the partnership agreement prohibited partners from transferring their interests without the consent of all of the other partners. Another reason given by the court for its conclusion was that the partnership agreement did not require profits to be distributed to the partners and in some years no distributions were made.
In John W. Fisher v. United States, the District Court for the Southern District of Indiana also held that interests in a family limited liability company were not present interests. The court relied on provisions of the operating agreement giving the manager discretion over distributions and another provision which allowed members to sell their right to receive distributions; however it granted the company a right of first refusal to purchase any interest a member desired to sell and to pay for the transferred interest by issuing a non-negotiable promissory note payable over up to fifteen years.
Interests in family entities such as limited partnerships and limited liability companies are not always the best choice for annual exclusion gifts, if other alternatives are available. Apart from this present interest problem, interests in these entities are hard to value and even if you are willing to pay for an appraisal each year there is no guarantee that the IRS will accept the valuation reached by the appraiser, especially where minority interest and other discounts are taken into account. If you do use these kinds of interests for annual exclusion gifts, consider including a provision in the partnership or operating agreement that is similar to the Crummey language used in trusts. Such a provision could allow the donee to require the entity to redeem the interest received by gift within 30 thirty days of the date of the gift. This may solve the problem presented by cases like Price and Fisher.