Underlying Assets Not Gift Tax Value of Interest in N.Y. LLC
In a taxpayer-friendly ruling, the Tax Court has held that a transfer of interest in a single-member limited liability company (LLC) should be valued for gift tax purposes as a transfer of an interest in the LLC rather than a transfer of its underlying assets.
In 2000, Suzanne Pierre organized the single-member Pierre Family LLC (Pierre LLC) under New York state law. She transferred $4.25 million in cash and publicly traded securities to the Pierre LLC in exchange for a 100% interest in the LLC. Shortly afterward, she transferred her entire interest in the LLC to two trusts she had established for the benefit of her son and granddaughter. She did so by gift of a 9.5% interest in the Pierre LLC to each trust and then a sale of a 40.5% interest in the LLC to each trust in exchange for secured promissory notes. The two notes each had a face amount of $1,092,133. Pierre filed a Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, reported the gifts to each trust and, after applying the unified credit, paid no gift tax on the transfers. For federal income tax purposes, Pierre LLC did not file a corporate return and was thus considered a disregarded entity under the “check-the-box” regulations.
The question at issue was whether the transfer of an interest in a single-member LLC that should be treated as a disregarded entity pursuant to the check-the-box regulations should be valued as a transfer of proportionate shares of the underlying assets owned by the LLC or as a transfer of an interest in the LLC. Under the check-the-box regulations, a single-member LLC that does not elect to be treated as a corporation is considered a disregarded entity for federal tax purposes (Treas. Reg. § 301.7701-2(b)(1)(ii)). A disregarded entity’s property and activities are treated in the same manner as those of a sole proprietorship—that is, as if they belonged to the owner of the entity.
The IRS argued that since Pierre LLC was treated as a disregarded entity, the transfers should be treated as transfers of proportionate shares of Pierre LLC’s underlying assets—the cash and marketable securities—rather than as transfers of interests in the LLC itself. Consequently, the Service said, the gifts should be valued based on the total value of the LLC assets, less the value of the promissory notes issued by the trusts. The IRS contended that besides the outright gifts, Pierre had made gifts to the trusts to the extent the value of the interests sold exceeded the value of the promissory notes. It calculated this amount as $629,117 for each trust (half of 81% of $4.25 million, minus $1,092,133).
The Tax Court held that while the check-the-box regulations determine how a single-member LLC is taxed for federal income tax purposes, they do not govern how a donor should be taxed under the federal gift tax provisions on a transfer of an LLC ownership interest. For federal gift tax valuation purposes, state law rather than federal tax law determines the nature of a taxpayer’s interest in transferred property, the court said, quoting Aquilino v. U.S., 363 U.S. 509 (1960). Under New York state law, an interest in an LLC is considered personal property, and a member has no interest in the specific property of that LLC. As a result, these transfers were properly valued as transfers of interests in Pierre LLC and not of its underlying assets, the court said.
By Karen M. Cooley, CPA, MBA, instructor of accounting, and Darlene Pulliam, CPA, Ph.D., McCray Professor of Business and professor of accounting, both of the College of Business, West Texas A&M University, Canyon, Texas.
