Ninth Circuit Holds That Transfers to LLC Were Not Indirect Gifts
Linton, 107 AFTR 2d 2011-565 , 630 F3d 1211 , 2011-1 USTC 60611 (CA-9, 2011).
In Linton, 1 the Ninth Circuit reversed the decision of a district court granting summary judgment in favor of the government in a case involving the transfer of assets to a limited liability company followed by gifts of interests in the LLC to trusts for the benefit of the taxpayers' children. The lower court ruled in favor of the government after applying the concept of indirect gifts and applying the step-transaction doctrine.
In November 2002, William A. Linton formed an LLC. On January 22, 2003, Mr. Linton and his wife, Stacy, met with their attorney. At the meeting Mr. Linton transferred a 50% interest in the LLC to his wife. At the meeting Mr. Linton also executed the following documents that transferred ownership of certain assets to the LLC:
(1) A deed transferring to the LLC a parcel of real property owned by Mr. Linton.
(2) An assignment of assets signed by Mr. Linton as assignor.
(3) Letters signed by Mr. Linton that authorized the transfer of securities and cash to the LLC.
The securities were actually transferred to the LLC between January 24 and January 31. In addition, at the meeting Mr. and Mrs. Linton and Mr. Linton's brother signed four separate trust agreements—one for each of the four Linton children. These trust agreements were signed by Mr. and Mrs. Linton as grantors and by Mr. Linton's brother as trustee. Also at the meeting, Mr. and Mrs. Linton each assigned an 11.25% interest in the LLC to each of the four trusts—thereby retaining a 10% interest in the LLC for themselves. The trust agreements and the assignments were left undated.
Two or three months after the meeting, the Linton's attorney assembled the documents. For all undated documents, the attorney filled in the missing date as 1/22/2003. In his deposition, the attorney stated that this insertion was erroneous, and that these documents should have been dated 1/31/2003. Mr. Linton agreed that January 31 was the correct date. The testimony by Mr. Linton was consistent with that of the Linton's accountant who had advised the Lintons on the transaction.
Some of the subsequent reporting and documentation of the transactions supported the Linton's alleged sequence of events. First, the LLC's federal partnership income tax return for 2003, prepared by the Linton's accountant, showed the contributions as initially being credited equally to Mr. and Mrs. Linton's individual capital accounts in the LLC. The return then shows capital transferred from their individual capital accounts and a commensurate increase in the capital accounts for the children's trusts. Second, Mr. and Mrs. Linton's federal gift tax returns for 2003, prepared by the attorney, described the gifts as percentage interests in the LLC and show the date of the gifts as 1/31/2003. Third, the LLC's membership interest ledger that was prepared by the attorney showed that Mr. Linton owned 100% of the LLC upon contribution of the real estate and portfolio assets to the LLC. The ledger also shows Mr. Linton's transfer of 50% of his interest in the LLC to Mrs. Linton. The ledger also shows their transfers of percentage interests in the LLC to the children's trusts. The ledger, however, does not record the dates for these transfers. Fourth, a valuation report, prepared by the Linton's accountant, stated that percentage interests in the LLC were transferred from the Lintons to the children's trusts on January 31.
In their federal gift tax returns for 2003, the Lintons characterized their gifts to the children's trusts solely as gifts of interests in the LLC. The Lintons claimed a discount of 47% due to the restrictions on ownership and control of the LLC interests. The IRS rejected the application of the 47% discount, arguing that: (1) the Lintons made indirect gifts of cash, securities, and real property to the children's trusts, or in the alternative that (2) the Linton's gifts should be treated as gifts of cash, securities, and real property under the step-transaction doctrine. Prior to a formal assessment by the IRS, the Lintons made an advance payment of the claimed tax deficiency and filed suit in district court seeking a refund of gift taxes paid.
The issue before the court was to determine whether the LLC interests were transferred before the Lintons funded the LLC (in which case the Lintons would be liable for the full value of the assets transferred to the LLC, as an indirect gift, to their children's trusts), or were the LLC interests transferred after the Lintons funded the LLC (in which case the Lintons would be entitled to marketability and minority discounts on the LLC interests transferred to their children's trusts). The assets were transferred to the LLC between January 22 and January 31.
The district court granted the government's motion for summary judgment. The district court determined that the transfers of cash, securities, and real property were made to the LLC either simultaneously with or after the gifts of the LLC interests to the children's trusts. Accordingly, the district court concluded that the Lintons' transfers of real estate, cash, and securities enhanced the LLC interests held by the children's trusts, thereby constituting indirect gifts to the trusts of pro rata shares of the assets conveyed to the LLC. The district court also determined, in the alternative, that even if the Lintons had proved that the cash, securities, and real property were contributed to the LLC before the gifts of the LLC interests to the children's trusts, the Lintons nevertheless made indirect gifts to the children's trusts under the step-transaction doctrine.
The Lintons appealed the district court decision to the Ninth Circuit, and the Ninth Circuit reversed the lower court's decision. The Ninth Circuit commenced its analysis by noting the four elements of a completed gift:
(1) An intention of the donor to make a gift.
(2) A subject matter capable of delivery.
(4) Acceptance by the donee.
The court noted that a gift occurs when all four elements exist simultaneously.
The court found that, based on the relevant state law (Washington) and the facts of the case, the last three elements of a completed gift were present. The court found that the only uncertain element was the point at which the Lintons manifested an intent to make the transfers to the children's trusts. The court stated that the gifts of the LLC interests to the children's trusts would be considered to have occurred at the first date at which objective circumstances existed that would indicate that the gift documents signed by the Lintons were meant to be operative. The court believed that the relevant objective circumstance could be, but was not necessarily, when the trustee was given a copy of the signed gift documents, because on that date the Lintons put the document beyond retrieval and thereby objectively manifested an intent to make the gift documents operative.
The court concluded that because the record was subject to contrary inferences as to when that, or some other event, objectively manifested the Linton's intent to make the gift documents operative had first occurred, the government was not entitled to summary judgment. The court, therefore, remanded the case to the district court for
such proceedings as it deems necessary to resolve that question.
The court also rejected the district court's application of the step-transaction doctrine as an alternative basis for its holding. The court found that the placing of assets into an LLC is an ordinary and objectively reasonable business activity that makes sense with or without any subsequent gift. The court also stated that the creation and funding of the LLC was a reasonable and ordinary business activity on the part of the Lintons because it enabled them to specify the terms of the LLC and contribute the desired amount and type of capital to it. For these reasons the court held that the government was not entitled to summary judgment based on the application of the step-transaction doctrine.
This case should serve as a reminder to attorneys regarding the importance of proper document execution. The mistake the Lintons' attorney made was having the Lintons execute all the documents on the same day (with some documents undated) rather than having the Lintons execute the documents over the course of several months (and dating the documents properly). If the attorney had followed this procedure, this case may never have arisen initially—thereby saving the attorney and client much grief. While we will have to wait to determine how this case is resolved on remand, it is nevertheless a significant taxpayer victory because the Ninth Circuit reversed the district court's application of the step-transaction doctrine to a common estate planning technique.
1. 107 AFTR 2d 2011-565 , 630 F3d 1211 , 2011-1 USTC ¶60611 (CA-9, 2011).
Frank S. Baldino is an estate planning attorney at Lerch, Early & Brewer. He has extensive experience in the areas of estate planning, charitable giving, estate planning for non-U.S. citizens, tax planning with respect to retirement plans and stock options, asset protection planning, business succession planning and estate and trust administration. For more information about gift planning, contact Frank at (301) 657-0715 or firstname.lastname@example.org.