Step Transaction Doctrine Collapses LLC Interest Gifts
In a second decision (Pierre II) involving Suzanne Pierre’s transfer of a single-member limited liability company (LLC) interest to two trusts, the Tax Court applied the step transaction doctrine to the gift and sale transactions at issue in the case and slightly reduced the lack-of-control discount. Previously, the court had ruled that the transfer of an interest in a single-member 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, despite the fact that the LLC was a disregarded entity under the check-the-box regulations (Suzanne J. Pierre v. Commissioner, 133 TC no. 2). See previous JofA Tax Matters coverage, “Underlying Assets Not Gift Tax Value of Interest in N.Y. LLC,” Dec. 2009, page 72.
Pierre organized the single-member Pierre Family LLC on July 13, 2000, and then created two trusts for the benefit of her son and granddaughter on July 24, 2000. She transferred $4.25 million of cash and marketable securities to the Pierre LLC on Sept. 15, 2000, in exchange for a 100% interest in the LLC.
Twelve days later she transferred her entire interest in Pierre LLC to the two trusts. The transfer was accomplished by a gift of a 9.5% interest in Pierre LLC and a sale of a 40.5% interest in Pierre LLC to each trust in exchange for a promissory note to each trust with a face amount of $1,092,133. The note amounts were based on an appraised value of a 1% non-managing interest in the LLC discounted for lack of control and lack of marketability. The notes had an interest rate of 6.09%, payable annually in 10 installments, and were secured by the 40.5% interests in Pierre LLC. The LLC made distributions to the trusts to cover the annual interest payments, and no principal payments were made. Pierre filed Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, for 2000 and reported the 9.5% gifts to each trust. No gift tax was paid, based on the appraised value of the interests and her available unified credit.
In Pierre II, the court first considered whether the step transaction doctrine should apply to collapse the four transfer transactions—two 9.5% gifts and two 40.5% sales. Pierre was unable to provide nontax reasons for separating the transfers into gifts and sales. The transfers were all made on the same day at virtually the same time. In addition, the taxpayer’s attorney recorded the transfers as gifts of 50% interests to the trusts in the journal and ledger used to prepare the LLC’s tax return. The court concluded that Pierre intended to transfer 50% interests to the trusts and structured them as part gift and part sale to avoid gift tax. The court held that Pierre made a gift to each trust of a 50% interest in Pierre LLC to the extent the interest exceeded the value of the promissory note executed by each trust.
The court also addressed the value of the 50% interest gifted to each trust. Initially, the taxpayer’s expert applied a lack-of-control discount of 10% and a lack-of-marketability discount of 30%. However, he revised the lack-of-control discount to 8%, since holding a 50% interest could allow a member to block the appointment of a new manager, whereas under the previously claimed 9.5% interest, a member would not have had that power. The court agreed.
The expert argued at trial that the marketability discount should be 35%, although the taxpayer previously had claimed 30%. The court accepted the 30% discount. The IRS did not offer any evidence or expert testimony regarding valuation of the Pierre LLC interests, since its original position was that the gifts were of the underlying assets of Pierre LLC.
By Karyn Bybee Friske, CPA, Ph.D., Pickens Professor of Business and associate professor 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.
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