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The Limitation that Hackl Creates for Family Limited Partnership Interests and Ways to Plan in Lieu of the Decision
Lauren Krauthamer[*]
Bethesda, Maryland
The Seventh Circuit recently affirmed the Tax Court’s decision that gifts of limited liability company interests did not qualify for the annual exclusion because the gifts were not gifts of a present interest. See Hackl v. Commissioner, 335 F.3d 664 (7th Cir. 2003). This creates challenges for taxpayers who want to make gifts of family limited partnership interests, which for tax purposes are treated similarly to limited liability company interests and interests in other gift and estate planning entities, when there is an intent to qualify for the annual gift tax exclusion.
The first section of this paper addresses gifts that qualify for the annual exclusion under I.R.C. § 2503(b) and the requirement that an annual exclusion gift be one of a present interest.  The second section of this paper explains the structure of a family limited partnership (FLP).   The facts in Hackl will then be examined in section three of this paper.  Lastly, section four addresses planning alternatives will be addressed in section four of this paper that provide a means for gifting FLP interests in light of Hackl.
Despite the unfavorable ruling in Hackl, taxpayers can satisfy the present interest requirement in order to make gifts of partnership interests eligible for the annual gift tax exclusion under § 2503(b).
I. Annual Exclusion Gifts
The Internal Revenue Code imposes a tax on “the transfer of any property by gift.” I.R.C. § 2501(a)(1). The gift tax is broad and applies “whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible.” I.R.C. § 2511(a). Under § 2503(b) every U.S. citizen can gift, to an unlimited number of donees, an amount up to the annual exclusion amount without being subject to gift tax.[1] Any gift exceeding the annual exclusion amount must be reported on the donor’s gift tax return and the Internal Revenue Service (“IRS” or “Service”) will assess gift tax on the amount exceeding the annual exclusion amount. Section 2503(b) states:
  In the case of gifts (other than gifts of future interests in property) made to any person by the donor during the calendar year, the first $10,000 [adjusted for inflation] of such gifts to such person shall not, for purposes of subsection (a), be included in the total amount of gifts made during such year. Where there has been a transfer to any person of a present interest in property, the possibility that such interest may be diminished by the exercise of a power shall be disregarded in applying this subsection, if not part of such interest will at any time pass to any other person.
Litigation over § 2503(b) has a long history. The Supreme Court ruled on a variety of issues pertaining to § 2503(b)’s predecessor in three cases on the same day in 1941. See Helvering v. Hutchings, 312 U.S. 393; United States v. Pelzer, 312 U.S. 399; Ryerson v. United States, 312 U.S. 405.
In Hutchings, the question presented was whether in the case of “a gift in trust for the benefit of the designated beneficiaries the single trust, or each beneficiary, is the ‘person’ to whom the gift was made and for which the deduction is allowed.” 312 U.S. at 395. The Court concluded that a gift is made to the beneficiary, not to the trust. See id. at 396.
The issue presented in Pelzer was whether gifts of property in trust, for the benefit of several beneficiaries, are gifts of present or future interests. See 312 U.S. at 399.  The Court considered what present benefit, if any, the beneficiaries were to receive.  The trust provided that income would accumulate for a ten-year period and would then be distributed to the beneficiaries. The Court concluded that “[t]he ‘use, possession, or enjoyment’ of [the beneficiaries] is . . . postponed to the happening of a future uncertain event” because there was no guarantee that the beneficiaries would survive this ten-year period and therefore the beneficiaries might never receive the trust income. Id. at 404. Because the beneficiaries of the trust did not have a right to the present enjoyment of the trust corpus or income, the gifts were held to be gifts of future interests, and therefore did not qualify for the annual exclusion. See id.
The taxpayer in Pelzer apparently believed that the gifts to the beneficiaries were present interests on the theory that the gifts were the legal interests in the trust, which the beneficiaries actually did possess. However, the beneficiaries did not have the enjoyment of the benefits of the trust until a later date.  The Court looked to the enjoyment of the trust assets as opposed to the interest in the trust in making the determination that the gifts were future interests.
Ryerson is a companion case to Pelzer and Hutchings; the Court considered the same issues and held similarly.
The above cases establish that in order for a gift to qualify for the annual exclusion the donee must receive a present interest, not a future interest, in the gifted property.  The 1941 test for a present interest may be referred to as the “present enjoyment test”.  The Court next visited this issue four years later in Fondren v. Commissioner, 324 U.S. 18 (1945).
In Fondren, the donors created seven irrevocable trusts, one for the benefit of each of their seven minor grandchildren, and funded the trusts with gifts of corporate stock.  The trust documents provided that the beneficiaries were to receive different percentages of the corpus at predetermined ages. The question presented to the Court, as with the earlier cases, concerned the distinction between a present interest and a future interest.
Specifically, the issue turned on “whether the interests acquired by the minor beneficiaries were ‘limited to commence in use, possession, or enjoyment at some future date or time.’” Fondren, 324 U.S. at 20 (quoting Pelzer and Ryerson).  A delay in enjoyment would indicate a future interest. Although the trust instrument provided that the trustee was to make distributions for the education, support, comfort, and maintenance of the beneficiaries if so needed, one trait of a present interest, the language of the trust indicates the grantors’ expectation that the beneficiaries’ parents were fully able to provide for and educate the beneficiaries.  The expectation that the beneficiaries were unlikely to require distributions weakened, if not wholly negated, the significance of the trust’s distribution provision. See Fondren, 324 U.S. at 22.
The taxpayer in Fondren believed that the terms of the trust made the trust interests present interests, and that, but for the fact that the beneficiaries were minors, the interest in the trust itself would satisfy the present interest test.  The Supreme Court, however, found the opposite; that the beneficiaries’ interest “was not absolute and immediate, but was conditioned, during minority and afterward until the times specified for distribution, upon a contingency which might never arise.” Id. at 24. The Court went on to explain that any delay in enjoyment constitutes a future interest, pointing out that “[t]he important thing is the certainty of postponement, not the certainty of the length of its duration.” Id. at 26.
Following the four year hiatus in annual exclusion cases broken by Fondren in early 1945, the Supreme Court again had occasion to visit this subject shortly thereafter in Commissioner v. Disston, 325 U.S. 442 (1945).  The taxpayer in Disston argued that the facts differed from those in Fondren because in Disston the trustee, unlike the trustee in Fondren, was required to provide for the education, comfort and support of the beneficiaries. See 325 U.S. at 448. The taxpayer intended to meet the present interest test set out in Fondren by requiring that the trust income be paid to the beneficiaries even though the beneficiaries did not require the income from the trust. See id.
This attempt to be distinguished from the problems faced by the Fondrens failed because “[i]n the absence of some indication from the face of the trust or surrounding circumstances that a steady flow of some ascertainable portion of income to the minor would be required, there is no basis for a conclusion that there is a gift of anything other than for the future.” Id. at 449.
If it can be determined when a beneficiary will receive a benefit from a trust, then the gift is more likely to be one of a present interest.  For example, if a trust requires that income from the trust is to be distributed periodically, such as annually, the gift of the income is deemed to be one of a present interest. If however, income is accumulated and paid over to the beneficiaries with the corpus at a later date, then the entire gift is a future interest. Fondren v. Commissioner, 324 U.S. at 21.
In 1958 the Internal Revenue Service embodied the relevant case law into regulations under I.R.C. § 2503. See 1958-2 C.B. 639. Treasury Regulation § 25.2503-(1) states that a present interest is “[a]n unrestricted right to the immediate use, possession, or enjoyment of property or the income from property (such as a life estate or term certain).” As explained above, the right to “use, possession, or enjoyment” connotes the right to “substantial present economic benefit”. Fondren v. Commissioner, 324 U.S. 18, 20 (1945). These words are not terms of art. See id. Rather, the test is subjective. “The question is of time, not when title vests, but when enjoyment begins.” 324 U.S. at 20; see also id. at 26-27.
Future interests are specifically not eligible for the annual exclusion according to I.R.C. § 2503(b)(1). A future interest is an interest which is “limited to commence in use, possession, or enjoyment at some future date or time . . . .” Commissioner v. Disston, 325 U.S. 442, 446 (1945). The regulations provide that future interests are not limited to “reversions, remainders, and other interests or estates, whether vested or contingent.” Treas. Reg. § 25-2503-3(a); see also Fondren, 324 U.S. at 20. The Supreme Court has drawn the distinction between present and future interests as “the barrier of a substantial period between the will of the beneficiary or donee now to enjoy what has been given him and that enjoyment”. Id. at 20-21.
In Chanin v. United States, 393 F.2d 972 (Ct. Cl. 1968), the taxpayers transferred shares of stock into a corporation that was a wholly owned subsidiary of a family corporation. The donees owned the shares but had no immediate right to the value of the donated property unless the family corporation liquidated its assets or declared a dividend, neither of which the donees could do without the cooperation of other owners.  For this reason, “[s]ince each stockholder-donee’s use, possession, or enjoyment of the gift property or its proceeds were so dependent upon contingencies beyond his control, the gifts must be considered gifts of future interests.”  Id. at 976, citing, inter alia, Ryerson v. U. S., 312 U.S. 405 (1941).
“Almost every future interest in property, if not subject to restrictions on alienation, confers some present benefit by virtue of the fact that the donee could dispose of it immediately.” Chanin, 393 F.2d at 977.  But the sale or transfer of an interest, especially one in a closely held entity, is not necessarily easy. Even though the donees in Chanin had the immediate right to sell, devise, or otherwise dispose of their future interest, the court found that this immediate right did not create a present interest in the property gifted due to the lack of marketability of the interest. See id. The court was unwilling to “do violence to the long established interpretation of [‘future interest’] by drastically limiting its meaning to property restricted as to alienation.” Id. at 978.
The taxpayer in Blasdel v. Commissioner, 478 F.2d 226 (5th Cir. 1973), affirming Blasdel v. Commissioner, 58 T.C. 1014 (1972), attempted to create a trust which would survive the alienability test set out in Chanin.  To do so the trust provided that the beneficiaries could sell the trust interests, reasoning that donees received “substantial present economic benefit” in the interest because each donee could, without restriction, dispose of the trust interest for a stipulated fair market value. See Blasdel, 58 T.C. at 1021 & n.10.
In deciding whether the ability to sell a trust interest creates a present interest in the donee, the court explained that the buyer of a donee’s interest would still “be in the donee’s shoes”, and like the donee before, the buyer would be “no more than the present owner of a future right. The interest given would still remain an expectancy with the use, possession, or enjoyment delayed.” Id. at 1022, quoting Alma S. Hay, 47 B.T.A. 247, 251 (1942).  The critical factor to examine, then, “is the interest which the donee received rather than the interest with which the donor parts”. Blasdel, 58 T.C. at 1018.
The trust in Blasdel provided that no distribution of income or corpus would be made unless all beneficiaries of the trust were in accord and unanimously agreed that such distribution be made or, in the alternative, a majority vote by the local bank’s board of directors approved such distribution.  The Tax Court found that since the beneficiaries’ enjoyment was contingent on unanimous agreement to receive distributions, the certainty of which was obviously unclear by virtue of the fact that the trust provided an alternate means to force distributions, the gifts were future interests. The Tax Court reasoned that
since ‘future interests’ unquestionably include even vested remainders, a form of property which is readily transferable, the mere power to realize some present benefit by an immediate disposition of a beneficiary’s interest will not suffice to convert an enjoyment which the donor has cast into the form of a postponed expectancy into a true present interest.  The mere power of present disposition can not be the test, or at least such estates as vested remainders would be present interests.
Id. at 1022.
In Calder v. Commissioner, 85 T.C. 713 (1985), the donors gifted gouaches[2] to a trust. The issue presented was whether the gouaches were gifts of present interests.  The trust instrument indicated that “the trustees, in the exercise of their absolute and uncontrolled discretion, may at one time or from time to time pay over to either of the beneficiaries from the principal of the Trust Estate.” Id. at 716. The Tax Court applied the test set forth by the Supreme Court in Commissioner v. Disston, 325 U.S. 442 (1945).  That test requires three factors to be met in order for a gift to qualify as a present interest.  First, the taxpayer must prove that the trust will receive income. Second, some portion of the income must flow steadily to the beneficiary. Lastly, the portion of income flowing out to the beneficiary must be ascertainable. See Calder, 85 T.C. at 727-28.
The Tax Court, applying the Disston test, found that the Calder trust failed the first prong and did not qualify as a present interest because the paintings gifted to the trusts would not generate income. See id. at 728. Furthermore, the beneficiaries would not receive a steady flow of income from the trust and therefore the amount of income was not ascertainable.  The court found that the taxpayer failed all three tests, the gifts conveyed no substantial present economic interest, and were therefore gifts of future interests.[3]
The past half-century of case law shows that for a taxpayer to make a gift qualifying for the annual exclusion, the gift must be one of a present interest, and the beneficiaries must receive a substantial economic benefit.  A problem that tends to arise in gifting interests is that donors want to maintain control of the gifted property and not give the beneficiaries any economic benefit while the donor is alive, yet the donors also want the assets removed from their estate at death. See, e.g., Thompson v. Commissioner, T.C. Memo 2002-246 (2002); Harper v. Commissioner, T.C. Memo 2002-121 (2002); Strangi v. Commissioner, 115 T.C. 478 (2000), aff’d in part, rev’d on § 2036 with remand to tax court, 293 F.3d 279 (5th Cir. 2002), on remand, T.C. Memo 2003-145.
Family limited partnerships provide a means for donors to transfer partnership interests while maintaining control over the underlying partnership assets.  However, as demonstrated by Hackl, taxpayers are currently faced with the serious issue of whether a family limited partnership can be structured so that a transfer of an interest in the entity is a present interest and thus qualifies for the annual exclusion.  Before discussing the Hackl case in detail, first is a brief discussion of family limited partnerships.
II. Family Limited Partnerships
The family limited partnership (“FLP”) is an estate-planning tool that provides individuals with significant tax and non-tax benefits.  The FLP provides transfer tax benefits by valuing the partnership interests transferred at a discount. Some non-tax benefits that FLPs offer are the ability of the donor to maintain control of the asset(s), protection of the asset(s) from creditors, and consolidation of assets.
Partnership Background
In general, an FLP is a partnership formed by two or more persons, with at least one general partner and one limited partner, to hold family assets. A general partner is “[a] partner who participates fully in the profits, losses and management of the partnership and who is personally liable for its debts.” Black’s Law Dictionary 1120 (6th ed. 1990).  The Uniform Limited Partnership Act (2001) “assumes that, more often then not, people utilizing the [Uniform Limited Partnership Act] will want (i) strong centralized management, strongly entrenched, and (ii) passive investors with little control over the entity.” UNIF. LIMITED PARTNERSHIP ACT § 406 cmt. a (2001).
A limited partner is “[a] partner whose participation in the profits is limited by an agreement and who is not liable for the debts of the partnership beyond his [or her] capital contribution.” Black’s Law Dictionary 1120 (6th ed. 1990).  “[A] limited partner is analogous to a shareholder in a corporation; status as owner provides neither the right to manage nor a reasonable appearance of that right.” UNIF. LIMITED PARTNERSHIP ACT § 302 cmt. (2001).
In a family limited partnership, typically, a nominal amount of general partnership interests are created for the senior family members and the balance are limited partnership interests for other family members. The senior family member thereby maintains control of the partnership assets as the general partner while transferring wealth to younger generations as limited partners.[4]
Transfer Tax Benefits
In FLPs, general partners typically gift limited partnership interests to family members via non-taxable annual exclusion gifts and/or taxable gifts. As discussed in Section I, gifts of limited partnership interests may or may not qualify as gifts of present interests for purposes of the annual gift tax exclusion, depending upon the facts of each particular case.  After Hackl, there is increased confusion about how to structure a limited partnership interest so that it qualifies for the annual exclusion gift.
For transfer tax planning purposes, a limited partnership interest is valued at a discount from the value of the underlying partnership assets.  The IRS allows the discount because fair market value is determined based upon the amount an objective, neutral, and willing buyer would pay for the limited partnership interest.  Since the limited partnership interests are illiquid, non-managing, interests in the partnership with no ready resale market, the interests would sell, if at all, at a substantially reduced value from the partnership’s underlying assets.[5]  These discounts decrease the potential gift tax associated with gifting the limited partnership interests to junior members of the family. Therefore, gifting limited partnership interests, as opposed to non-discounted assets, enables the taxpayer to leverage their assets.
The overriding objective of a FLP for estate tax purposes is to ensure that the transferred partnership interests are not included in the transferor’s estate.  In order to increase the possibility of this result the partnership agreement should specify that the general partner, in managing and operating the partnership, is bound by fiduciary obligations to the other partners. See Byrum v. United States, 408 U.S. 125, (1972).
Many donors choose to gift interests in FLPs as their annual exclusion gift.  When gifting the annual exclusion amount the donor does not pay gift tax on the transferred assets. The assets are removed from the donor’s estate, and the donor does not use any portion of the estate tax exemption amount.[6] The most critical factors to consider in determining whether a gift of an FLP interest will qualify for the annual exclusion include: the donee’s ability to transfer the interests, the donee’s right to vote, the donee’s right to receive distributions, and whether the general partnership has a fiduciary obligation to the donees.
Hackl is the most recent case regarding present interest gifts and the one that applies to annual exclusion gifts of FLPs.
III. Hackl
For years the courts have not decided any landmark cases dealing with whether gifts of FLP interests qualify for the annual exclusion.  In 2002 the Tax Court heard a case filed by A.J. and Christine Hackl, in which the Hacklsdisputed the commission’s contention that their gifts of interests in an LLC (similar to FLP interests) were future interests and not eligible for the annual exclusion. In 2003, the Seventh Circuit heard the Hackls’ appeal and affirmed the Tax Court. See Hackl v. Commissioner, 335 F.3d 664 (7th Cir. 2003), aff’g 118 T.C. 279 (2002).
A.J. and Christine Hackl purchased two tree farms that they contributed, along with cash and other securities, to Treeco, LLC (“LLC” or “Treeco”). See Hackl v. Commissioner, 118 T.C. 279, 281 (2002).  The primary purpose of forming the LLC was long-term investment. Id.  By the time this case reached the Court of Appeals, Treeco had operated at a loss and made no distributions to its owners.  See Hackl v. Commissioner, 335 F.3d 664, 666 (7th Cir. 2003). The Hackls gifted interests, including non-voting shares and fifty-one percent of the voting shares in the LLC, to their children, their children’s spouses, and a trust established for the grandchildren. See Hackl v. Commissioner, 118 T.C. 279, 284 (2002). A.J. and Christine Hackl claimed these gifts on their tax return as annual exclusion gifts. Id. Unfortunately for A.J. and Christine, the IRS contended that the gifts did not qualify for the annual exclusion because the gifts were future interests which do not qualify under § 2503(b). Id. at 285.
The terms of an operating agreement (or partnership agreement, as the case may be) are highly relevant in analyzing whether or not the interests are gifts of a future interest or a present interest. See Hackl, 118 T.C. at 282-84 (analyzing five paragraphs of the Treeco, LLC operating agreement to determine the rights of the beneficiaries). The pertinent terms of the Hackl’s operating agreement are as follows.
A.J. Hackl would be the manager of the LLC and would: serve for life (or until resignation, removal, or incapacity), control financial distributions, have the power to appoint a successor (during lifetime or by will), and have the authority to dissolve the company. Id. at 282. The agreement specified that the manager “shall perform the Manager’s duties as the Manager in good faith, in a manner the Manager reasonably believes to be in the best interests of the Company, and with such care as an ordinarily prudent person in a like position would use under similar circumstances.” Hackl v. Commissioner, 118 T.C. 279, 282 (2002).
While A.J was the manager, the LLC could be dissolved only in his sole discretion. See id. at 283. After his tenure as manager, the LLC could be dissolved by an eighty percent majority vote of the voting members. Id.
The fact that A.J. solely controlled all of the financial distributions, id. at 282, is particularly relevant with regard to the analysis of whether the gifts qualified as present interests because, as explained by the Supreme Court in Disston, discretionary versus required distributions are a key factor in determining whether an interest is a present or a future interest.  If no distributions are made to the beneficiaries then it can be argued that the beneficiaries did not receive a present interest because the beneficiaries do not have any present substantial economic benefit.
The Treeco operating agreement also provided that interests were not assignable. Id. at 283. Members of the LLC needed the manager’s approval to withdraw from the company or to sell company shares. Id.  The beneficiaries therefore could not receive an economic benefit from the sale of the shares.  If a member transferred shares in violation of the agreement the transferee would only receive the shares’ economic rights. See Hackl v. Commissioner, 118 T.C. 279, 283 (2002).
The transferee had no membership or voting rights in the LLC. See id. Voting members of the LLC could remove the manager and elect a new manager, which the transferees could not do. Id. With an eighty percent majority vote, voting members could amend the Articles of Organization and operating agreement. Id. Therefore, the transferees did not have the power to amend the agreement to provide them with an economic benefit. 
After the LLC was formed, A.J. and Christine Hackl began making annual transfers of Treeco voting and nonvoting shares to their children, children’s spouses, and trusts for their grandchildren. Id. at 284. The Hackls treated the gifted shares as excludable gifts, attempting to qualify for the annual exclusion under § 2503(b), on their gift tax returns. Id. The IRS disallowed the exclusions, asserting that the transfers did not qualify for the annual exclusion because the transfers did not constitute gifts of a present interest for purposes of § 2503. See Hackl v. Commissioner, 118 T.C. 279, 290 (2002). Rather, the transfers were gifts of future interests. Id.
Tax Court Opinion
The Tax Court affirmed the IRS, holding that in order to qualify for the annual exclusion the donees must have a present interest in property.  The court explained that
  a taxpayer claiming an annual exclusion to establish that the transfer in dispute conferred on the donee an unrestricted and noncontingent right to the immediate use, possession, or enjoyment (1) of property or (2) of income from property, both of which alternatives in turn demand that such immediate use, possession, or enjoyment be of a nature that substantial economic benefit is derived therefrom.
Hackl, 118 T.C. at 293.
First the court looked at the property gifted when the LLC shares were transferred.  The issue presented was whether the gift of the property itself, Treeco, LLC units, conferred a present interest on the donee. The Tax Court, relying on Fondren, concluded that whether a gift is direct or indirect, § 2503(b) is concerned with and requires meaningful economic, rather then merely paper, rights. See Hackl, 118 T.C. at 291. Although the donees in Hackl received title to the Treeco units,
[i]t is incumbent upon petitioners to show the present (not postponed) economic benefit imparted to the donees as a consequence of their receipt of Treeco units. . . . All the facts and circumstances must be examined to determine whether a gift is of a present interest within the meaning of § 2503(b), and this will be true only where all involved rights and restrictions, wherever contained, reveal a presently reachable economic benefit.  Since here the primary source of such rights and restrictions is in the Treeco Operating Agreement, its provisions, in their cumulative entirety, must largely dictate whether the units at issue conferred the requisite benefit.
Id. at 295.
The Tax Court found that the terms of the operating agreement prevented the donees from obtaining value on their own from their LLC units because the operating agreement did not allow the donees to unilaterally withdraw the donees’ capital account. See id. at 297. The manager had to consent to members receiving capital contributions. Id. If a member wanted to sell Treeco units the member could only offer the units for sale to the company.  The manager had the discretion to accept, reject or negotiate the terms of the sale. Id. A contingency therefore stood between any member and the member’s receipt of economic value for the units held.  Lastly, a dissolution of the LLC could entitle members to distributions, but no donee acting alone could effectuate a dissolution. See id. at 283.
The operating agreement stated that
  [n]o member shall be entitled to transfer, assign, convey, sell, encumber or in any way alienate all or any part of the Member’s interest except with the prior written consent of the Manager, which consent may be given or withheld, conditioned or delayed as the Manager may determine in the Manager’s sole discretion.
Hackl v. Commissioner, 118 T.C. 279, 297 (2002). The Tax Court concluded that a transfer contingent upon manager approval is not a present interest. See id. at 298-99.
In the words of the court, operating agreements may restrict members’ ability to dispose of an interest in the entity without prior consent of the manager. See Hackl v. Commissioner, 335 F.3d 664, 667 (7th Cir. 2003).  There are many variations on this theme. According to the Treeco operating agreement, as stated above, there were substantial restrictions on alienability. Id.  The operating agreement anticipated this issue and, perhaps in an attempt to increase the perception of marketability, provided that in the event that the manager did not grant permission to transfer an interest, the shareholder could “violate” the agreement and sell shares without the manager’s approval. Id. at 668. The problem with this “solution” is that a transferee would have no membership or voting rights. Id. In the words of the Seventh Circuit, this is “hardly . . . a substantial economic benefit” and not a present interest. Id.
Ownership interests in partnerships and LLCs can be broken down into economic and voting components. Id. As described above, the economic component in some instances can be transferred without the voting component.  The drawback to the purchaser in such a situation is that they have no voting right and therefore less participation in management.  And, there is still no guarantee of income distributions, which may be made at the manager’s discretion.
The Hackls defended their position by arguing that the restrictions on alienability in the Treeco operating agreement are common practice in closely held entities. See Hackl v. Commissioner, 335 F.3d 664, 667 (7th Cir. 2003). The Seventh Circuit agreed with this position, but explained that the popularity of this type of provision has no effect on whether gifts of such interests qualify for the annual exclusion. Id.
When a restriction on alienability applies, the transferred interest is valued at less then it would be in the hands of the original transferor. Therefore, very little economic benefit could be derived from selling Treeco units, since the potential transferee has no right to become a voting member or to receive income distributions.  Based on the lack of marketability, the Tax Court concluded, see Hackl v. Commissioner, 118 T.C. 279 (2002), and the Seventh Circuit agreed, see Hackl v. Commissioner, 335 F.3d 664 (2003), that the gift of the Treeco units, the property itself, does not confer upon the donees the use, possession, or enjoyment of property within the meaning of § 2503(b).
This issue of alienability was addressed in Chanin, where the Court of Claims held that even an immediate right to dispose of an interest does not create a present interest if there is a lack of marketability. See Chanin v. United States, 393 F.2d 972, 977 (Ct. Cl. 1963).
In the second part of the Tax Court’s analysis, the court considered whether the income from the gifted property conferred a present interest upon the donees.  The court used the three-part income test, as formulated by the Supreme Court in Disston, 325 U.S. 442 (1945), to determine whether the donees’ right to income satisfies the criteria for a present interest under § 2503(b)See Hackl, 118 T.C. at 298; see also Calder v. Commissioner, 85 T.C. 713, 727-28 (1985).  As discussed below, the Hackl operating agreement failed all three parts of the test.          
First, the taxpayer must prove that the trust will receive income.  The primary business purpose of the LLC was to acquire and manage timberland for long-term income and appreciation, “and not to produce immediate income.”  Additionally it was anticipated that the LLC would operate at a loss for a number of years and therefore the LLC did not anticipate making distributions to shareholders during these years.  Since it was not proven that the LLC would receive income, the first part of the Disston test is not met.
Second, the operating agreement should provide that some portion of the income will flow steadily to the beneficiary. The Treeco operating agreement did not indicate that members would receive distributions even if there were positive cash flows.  Members received income only when in the managers discretion distributions would be made. “This makes the timing and amount of distributions a matter of pure speculation . . . .” Hackl v. Commissioner, 118 T.C. 279 at 298. Since no portion of income will flow steadily to the beneficiary, the second part of the test is not met.
Third, the portion of income flowing out to the beneficiary must be ascertainable.  In the Treeco operating agreement, no portion of income that was to flow out to the donees was ascertainable. “Entity interest values can be based . . . on the worth of the underlying assets and the future income potential they represent, neither of which may be presently reachable.” Hackl v. Commissioner, 118 T.C. 279, at 299.  Therefore, the third part of the Disston test was not met.  Based upon the income analysis, the income from the gifted property did not confer upon the donee a present interest.
The Tax Court concluded, based upon its two-tiered analysis, analyzing both the property and income from the property conferred upon the donees,  that the LLC transfers did not bestow upon the donees a present interest and therefore the Hackls could not qualify the transfers in the entity as annual exclusion gifts.
Seventh Circuit Opinion
The Seventh Circuit affirmed the Tax Court holding that transfers of member interests in an LLC were gifts of future interests that did not qualify for the annual tax exclusion gift under § 2503(b) because the gifts, while outright, were not gifts of present interests.  See Hackl, 335 F.3d 664, 668 (7th Cir. 2003).
On appeal the Hackls argued, generally, that a gift is a future interest only where the donee receives less then the “full bundle of legal property rights.” Id. at 666.  Since the Hackls gave up all of their property rights to the LLC interests they proposed that the gifts were present interests and thus qualified for the annual exclusion. See id. The IRS, not surprisingly, interprets the definition of “present interest” more narrowly.  The Service argues “that any transfer without a substantial present economic benefit is a future interest and ineligible for the gift tax exclusion.” Id. at 667.
The court looked with a skeptical eye on the Hackls’ first argument, which was that the “plain – and only – meaning of ‘future interest’ as used in the statute” supports their position. Id.  Furthermore, the Hackls argued that the Tax Courts reliance on case law and the Internal Revenue Service’s definition of the term “future interest” was not only unnecessary but also wrong. Id.  However, the Hackls cited no cases that characterize § 2503(b) as plain, nor can one rely on the statute for the definition of “future interest” because the term is not defined in the statute. See Hackl, 335 F.3d 664, 668 (7th Cir. 2003). Needless to say, the Seventh Circuit disagreed and commented that “[c]alling any tax law ‘plain’ is a hard row to hoe, and a number of cases . . . have looked beyond the language of § 2503(b)(1) for guidance.” Id.
Prior to the Seventh Circuit’s decision in Hackl, the court was presented with the issue of present versus future interest in Stinson Estate v. United States, 214 F.3d 846 (7th Cir. 2000).  In that case the issue was whether forgiveness of corporate debt qualified for the annual exclusion.  The court decided that the forgiveness of the debt did not qualify for the annual exclusion because it was not a gift of a present interest.  The shareholders may have recognized an increased value in the shares of stock in the corporation but the shareholders could not realize this increase without either liquidating the corporation or declaring a dividend and therefore the forgiveness of debt was a future interest. See id. at 848.  As the court has said in cases involving a trust, “the sole statutory distinction between present and future interests lies in the question of whether there is postponement of enjoyment of specific rights, powers or privileges which would be forthwith existent if the interest were present.” Hackl, 335 F.3d at 667, quoting Stinson Estate, 214 F.3d at 848-49 and Howe v. United States, 142 F.2d 310, 312 (7th Cir. 1944).
When a U.S. Court of Appeals files an opinion disagreeing with a common planning technique, i.e., annual exclusion gifts of LLC interests in Hackl, practitioners become concerned that the interpretation of the law may change. The ramifications of the ruling not only affect annual exclusion gifts of the closely held entity interest but also the valuation discounts of these gifts.
What practitioners find most disconcerting about the ruling is that the Treeco operating agreement contains language common to many operating agreements for closely held entities. “IRS Wins Round One in Court Battle Regarding Gifts of LLC Interests”, Craig Stephanson and Jeff Bae, 70 Prac. Tax Strat. 81 (Feb. 2003).  Some common language includes provisions such as:  “the manager had full management control of the LLCs business and investments; the manager had control over cash distributions; no member had the right to withdraw the member’s capital contribution; no member had the right to transfer or assign his or her interest without the written consent of the manager.” Id.
More specifically, as applied to the facts in Hackl, the beneficiaries of the LLC interest did not receive any income distributions from Treeco, could not sell the LLC interest without approval from the manager, and could not use their voting interest to obtain any meaningful economic benefit.  A.J. Hackl maintained complete control over the Treeco entity.  The beneficiaries did not have the right to the immediate use, possession or enjoyment of the property or the income therefrom.  Therefore, no substantial economic benefit was transferred as required by§ 2503(b), and thus a present interest was not transferred.
The dilemma created for taxpayers is that “the restrictive language of an entities operating agreement that allows taxpayers to claim valuation discounts could also be used to disallow a claim for the gift tax annual exclusion.” Id.  Therefore, taxpayers must decide whether to “1) make a gift of the interest and claim valuation discounts based on the restrictive nature of the operating agreement or 2) make a gift of the interest (presumably in smaller shares) and claim the gift tax annual exclusion based on a less restrictive operating agreement.” Id.   The next section discusses planning approaches that strengthen a taxpayer’s argument that the gift tax annual exclusion applies and the potential impact that planning technique may have on the valuation of the gifted property.
IV. Alternative ways to qualify gifts of FLP interests for the annual exclusion
Although the court in Hackl did not find the gifts of the LLC interests to be gifts of present interests qualifying for the annual exclusion, a tax planner can minimize the possibility that gift tax will have to be paid or that the estate tax exemption will have to be used on gifts of entity interests by taking into account the rights that the donee receives under the partnership agreement and under state law.  The following discussion provides some of these planning techniques and a brief explanation regarding the effect that the technique may have, if any, on the valuation of the gifted interest.[7] 
Use of Estate Tax Exclusion Amount
One approach is for a taxpayer to gift an interest in an FLP using the estate tax exclusion amount. See I.R.C. § 2010. Every taxpayer is entitled to a lifetime estate tax exclusion amount.  This exclusion amount provides a means for individuals to pass a certain amount of money on to future generations, during life or at death, without being subject to gift or estate taxes on that stated amount. For tax year 2003, the estate tax exclusion is $1 million. See supra note 6 (listing changes in the estate tax exemption).  In addition to the estate tax exemption amount, taxpayers are eligible for a yearly annual exclusion amount. The annual exclusion is separate from the exemption amount. See I.R.C § 2503(b). However, if a taxpayer gifts an amount above the annual exclusion it will reduce that taxpayer’s lifetime exemption amount.  By gifting an FLP interest using the lifetime exemption amount no gift tax is paid and the valuation discount is still preserved.
The downside, however, is that the taxpayer is using the lifetime estate tax exemption amount as opposed to the annual exclusion gift. The annual exclusion gift can be made to an unlimited number of donees. Id.  The exemption is not unlimited because once the dollar limit has been gifted, then all future gifts above the yearly annual exclusion amount will be subject to gift tax during life or estate tax at death. See I.R.C. § 2010(c).
Fiduciary Duty Clause
A strategy that can increase the probability of qualifying a gift of an FLP interest for the annual exclusion is that the general partner or trustee be subject to a fiduciary duty either in the partnership agreement, trust document, or under state law. [8] Fiduciary duties help to ensure that the general partner will act in the best interest of the limited partners,[9] demonstrating that the assets truly are for the benefit of the donee.
Letter rulings and technical advice memoranda issued by the IRS suggest that including such a provision in a limited partnership agreement allows a gift of the partnership interest to qualify as a present interest under § 2503(b).[10]   Based upon these rulings if the agreement has other restrictions, such as those presented in Hackl, i.e., transferability restrictions and control of distributions, the interests will qualify as a present interest and thus the annual exclusion.
There is a difference between partners and trustees because the fiduciary duties of a general partner are not equivalent to the discretionary authority of a trustee.  A general partner does not have the power to postpone or withhold partnership income, as a trustee may have with discretionary authority. See Tech. Adv. Mems. 8611004 and 9131006.  Including a fiduciary duty clause helps ensure that the general partner will be subject to a higher standard by preventing the general partner from abusing the position to the detriment of limited partners. See U.S. v. Byrum, 408 U.S. 125, 142 (1972).  The same principle applies to managers in LLCs where the operating agreement contains a fiduciary duty clause. 
The fiduciary duty provision should include language that describes the manager’s fiduciary duties.  The duties include managing and operating the entity in the best interests of the entity and its owners.  This clearly relates to the need to provide owners with “present use and enjoyment” of an asset because an owner’s best interests are not necessarily served by the manager withholding profits.
Remove Trustee Discretion
Discretion allows the trustee tomake decisions, e.g.,decide when to make distributions, how much the distributions should be, the means in which distributions can be made. This discretion means that the beneficiary lacks definite substantial present economic benefit.
The I.R.S. regulations provide guidance on the effect discretion of a trustee has on the type of interest gifted in part by way of example. One example states that a gift in which the donee’s right to receive payments of a trust’s income is subject to a trustee’s discretion is not a present interest. See Treas. Reg. § 25.2503-03(c) (Example 1); see also Fisher v. Commissioner, 132 F.2d 383 (9th Cir. 1942). The reasoning is that if a trustee has discretion to issue a distribution, which is the sole means of conferring “substantial present economic benefit,” then there is no guarantee that the donee will receive a distribution and therefore an economic benefit. Likewise, a trustee’s discretion to determine the amount of income to be distributed could be problematic because the amount cannot be ascertained.
Removing discretion by requiring, for example, an annual amount certain to be distributed would confer a present interest.  Thus the gift would be ascertainable and be more likely to survive scrutiny.[11] 
As with earlier cases, the dispute hinges on discretion.  A requirement in Calder, 85 T.C. at 728 n.17, that the trustee invest in income producing assets may meet the present interest test. In Hackl, if the manager was required by the operating agreement to make income distributions to the beneficiaries of a fixed and ascertainable amount it is more likely that the court would have found the LLC interest to be a present interest.
The Fourth Circuit, in Maryland National Bank v. U.S., 609 F.2d 1078 (1979), found that a gift of a partnership interest did not qualify as a present interest because the economic benefit bestowed on the beneficiaries was unascertainable.  There was no income being produced by the partnership for distribution and there was no sign that income was going to be produced in the future. On the other hand, if the beneficiaries had a right to withdraw principal from the trust then this would qualify as a present interest even if no income is currently generated.  See TAM 8611004.  The beneficiary in this situation is not dependent on a trustee’s discretion.
A potential downside to requiring distributions is that the donor may not want the beneficiaries to have the income currently.  Instead the donor may prefer that the income remain in the entity and appreciate for future years.  Additionally, income distribution requirements relinquish the donor’s control over the assets distributed from the entity.
Crummy Powers
Another means to avoid the problem presented in Hackl is to attach crummy powers to the gift of an interest in an FLP.  Crummy powers are based upon the case Crummy v. Commissioner, 397 F.2d 82 (9th Cir. 1968).[12] In Crummy, the Ninth Circuit found that if beneficiaries have the right to demand an immediate distribution of a certain dollar amount, within a certain period of time, the gift is a gift of a present interest. 
A crummy power attached to a gift of an FLP interest allows the donee to either make a withdrawal or demand a distribution of a particular amount within a certain period of time once the gift has been made.  The time period in which a demand can be made is customarily a period of thirty days.   It is this ability to demand the distribution, whether or not actually demanded by the donee, that categorizes the gift as a gift of a present interest and therefore qualifies for the annual exclusion.
Some estate planners recommend sending a letter to the beneficiaries each year stating that a thirty-day window is open where the beneficiaries can demand a withdrawal as opposed to placing the crummy power in the entity documents.   In some cases a “put right” is also included in the letter. A “put right” presents an option to the beneficiary that they can either withdraw an interest in the entity and if they do not they have the option of requesting the fair market value of the entity in cash. The ability for the beneficiary to demand cash creates the present interest.
A sample put right is as follows:
Put Right of Certain Transferees. If a Permitted Transferee (“the Donee”) receives a Limited Partnership Unit as a gift (the “Gift Unit”) from [here insert the names of the individual partners who will be making annual exclusion gifts of partnership units, such as “John Doe, Mary Doe, or Richard Doe”], the Donee shall have the right to “put” the Gift Unit to the Partnership at its External Fair Market Value.  This right may be exercised by executing and delivering to the General Partner all documents necessary to transfer the Gift Unit to the Partnership, accompanied by written notice that the Donee is exercising his put. Upon receipt of such documents and notice, the General Partner shall forthwith transfer to the Donee, in exchange for the Gift Unit, cash or property (of any type) having a fair market value equal to the External Fair Market Value of the Gift Unit. This right of the Donee shall expire, as to the Gift Unit, thirty (30) days after the date of the gift of such unit. 
Rumors have been circulating in the estate planning community that the IRS has suggested that a put right does not qualify as a crummy interest.  See, e.g., Turney P. Berry, Esq., Address at the MICPEL Advanced Tax Institute Estate Planning Issues (Nov. 5, 2003). A crummy interest is supposed to give the beneficiary an interest in the underlying assets of the entity.  For example, if a trust holds IBM stock then the crummy power should give the beneficiary the option to withdraw IBM stock from the trust.  If, however, the beneficiary is given a put right for cash then the beneficiary is not getting an interest in the underlying asset of the entity. Therefore a true crummy power may not exist, and therefore the gift may not be a present interest.
A disadvantage of using crummy powers is that the valuation discount on the interest may be lowered because the donee would have the ability to realize the current value of the interest within a definite period of time.[13] This ability may make the interest more marketable and therefore decrease the marketability discount. This should not be a problem if the amount that can be withdrawn is based on the fair market value of the interest, where the value is determined by taking into account all “valuation discounts,” but not taking into account the sell-back or withdrawal right.[14]
Another problem with the withdrawal right is that the right might be exercised, forcing the partnership to pay out cash or other property. This may be detrimental to the partnership or there may be other reasons that they may not want or be able to do at that time. However, children and grandchildren can be persuaded to not exercise their right so that they will enjoy the benefits of their interests in the future.
Right of First Refusal
Another factor to consider in determining whether a gift is one of a present interest is the donee’s ability to sell the interest without substantial restraint. See P.L.R.s 9710021, 9415007 and Tech. Adv. Mems. 8611004, 9131006. This is an issue because donees typically do not want outsiders to become owners without prior consent of the current partners. If the donee can not dispose of the interest without substantial financial detriment, then the donee will be treated as not having the right to currently enjoy the interest and the gift will not qualify as a present interest.  A solution to this problem is to have the agreement provide for the other partners to have a right of first refusal in future sales of partnership interests. This would not unduly hinder transferability and the gift would qualify as a present interest.[15]  This mutually beneficial type of provision in the partnership agreement is more likely to provide the beneficiary with a present interest while at the same time providing existing partners with control.
A right of first refusal clause restricts the transferability of an ownership interest in an entity.  In Hackl the donee had to get the manager’s permission before being able to sell an interest in the LLC, restricting the transferability and preventing the interest from qualifying for the annual exclusion.  However, had the agreement had a right of first refusal, then the members would have been able to sell their interest to management instead of to a third party.      The partnership agreement should state that partners transferring their FLP interests are required to notify and present the third party’s offer to the other FLP owners so that the current owners have the opportunity to purchase the interests under the same terms offered to the third party. A right of first refusal thus allows current partners a right to preempt outside purchasers while at the same time allowing current partners a means to sell entity shares and realize the current value of the shares.
By realizing the current value of the shares the taxpayer can argue that this supports the present interest characterization under the property test in Hackl.  If a right of first refusal is present, then the annual gift tax exclusion can be claimed when gifting such interest because the seller can realize the current value of the ownership interest.  Additionally, the taxpayer would be able to qualify for the valuation discounts for gift and estate tax planning purposes.[16]
Some of the possible drawbacks of a right to first refusal are, first, the strategy could decrease the discount value because the marketability of the interest may be increased.  However, this potential decrease in valuation would probably be small because limited partnership interests are not very desired even in the absence of a right of first refusal provision.
A second potential problem is that if the limited partner did find someone to purchase his or her interest, then the partnership has to choose between buying the interest and allowing a new person to join.[17]
A sample of a right of first refusal clause is as follows:
Right of First Refusal. If a Partner desires to dispose of such Partner's Partnership Interest during said Partner's lifetime, said Partner shall first offer all of said Partnership interest to the remaining Partners at a price determined in accordance with the provisions of [insert section of partnership agreement]. The remaining Partners may purchase the entire selling Partner's Partnership interest but not a portion of said interest unless otherwise agreed to by the selling Partner.
  If all of the selling Partnership Interest is not purchased by the remaining Partners within 60 days after receipt of the offer the offering Partner may then sell the balance of such Partnership Interest to any other Person but shall not sell it without first giving the remaining Partners the right to purchase such selling Partner's Partnership Interest on 10 days' notice at the price and upon the terms offered to such other person. The remaining Partners must be provided with a written copy of the purchase contract executed by the prospective purchaser.  If the remaining Partners do not purchase the selling partner's interest and the selling Partner does not close on the sale of the selling Partner's Partnership Interest with the prospective purchaser within 60 days after the expiration of such 10 days' notice, the selling Partner must fully comply with all of the terms and conditions of this Section as if no prior offer to purchase had been received by the selling Partner.
  Any selling Partner's Partnership Interest purchased by the remaining Partner, by an outside party, or not so disposed of by sale to an outside party shall remain subject to the terms of this Agreement.
Temporary Right to Sell
Another option is to allow new limited partners the right to sell their interests to anyone, including outsiders, but only during a fixed period of time. One problem associated with this option is that the existing partners would not have any input over the new partners if the right to sell were actually exercised.  Also, this may decrease the valuation discount due to the increased marketability but not necessarily, due to the illiquid market for interests in closely held entities.
Qualify Under the Income Test
Another way to help to ensure that a gift of an FLP interest qualifies for the annual exclusion is to meet the Supreme Court’s three-part income test. See Commissioner v.Disston, 325 U.S. 442 (1942).  Satisfying the income test may help indicate that the beneficiaries have the right to “use, possession, or enjoyment” of the property where a beneficiary may not be able to sell the underlying partnership assets to receive a substantial present economic benefit.
First, the FLP must be income-producing. Attorneys can recommend to clients creating FLPs that they contribute income-producing assets to the entity. Almost any income producing asset should be satisfactory; assets such as apartments or some other rental property are popular. The Tax Court indicates that rental income from assets placed into a trust meets this portion of the test. Calder v. Commissioner, 85 T.C. 713, 728 (1985).
Second, the taxpayer must ensure that the FLP provides a steady flow of income to the partners. This can be accomplished by placing a requirement in the partnership agreement that distributions must be paid to the limited partners on, for example, an annual basis. 
Third, the amount of the distributions to be made to the limited partners should be of an ascertainable amount.  For example, the operating agreement should provide either a specific dollar amount to be distributed or a formula with an ascertainable value. 
Cash Gifts
Taxpayers could give the annual exclusion amount in cash to their beneficiaries with the understanding that this money would be used to purchase interests in the FLP.  A potential problem however, is that if the purchase is made too close in time to the gift this might, under the step transaction doctrine,[18] be treated as a gift of a limited partnership interest. Additionally, the partnership may have to recognize gain on the sale of the interests to the beneficiaries. Lastly, the beneficiaries could decide to use the money for some other purpose and not purchase the partnership interest.
As the last sixty years of case law demonstrates, taxpayers regularly make gifts which they hope will qualify for the annual exclusion.  However, many of these gifts do not qualify because the gifts are gifts of a future interest rather than a present interest for tax purposes. And as courts have ruled time and time again, it can be difficult for taxpayers to avoid the future interest trap through clever legal planning.  The Tax Court has long recognized that “[b]ecause of the many and varied ways in which gifts . . . may be made, there is no simple rule by which to discern present from future interests.  Rather it is necessary in each case to scrutinize the . . . provisions and the surrounding circumstances and decide the case on its individual facts.” Blasdel v. Commissioner, 58 T.C. 1014, 1018 (1972); see also Commissioner v. Kempner, 126 F.2d 853, 854 (5th Cir. 1942). 
Practitioners should be cautious due to the decision in Hackl, but FLP interests can still be gifted via the annual exclusion so long as a substantial present economic benefit is bestowed upon the donees.  In order to ensure that gifts of entity interests will qualify for the annual exclusion donors should be more willing to relinquish control when gifting entity interests.
[*] Thank you to my husband Michael for all of his love and support.
[1] The annual exclusion amount is $11,000 for the 2003 and 2004 tax years. See Rev. Proc. 2002-70, Section 3.24; Rev. Proc. 2003-85, Section 3.26. The primary purpose of the exclusion is to “obviate the necessity of keeping an account of and reporting numerous small gifts.” S. Rep. No. 665, 72d Cong., 1st Sess. (1932) reprinted in 1939-1 (Part 2) C.B. 496, 525.
[2] A gouache is “a form of original painting executed with opaque watercolors.”  Calder, 85 T.C. 713 at 714 n.2, citing THE RANDOM HOUSE DICTIONARY (rev. ed. 1982).
[3] Although the trust instrument gave the trustees discretion to sell the paintings with the effect of generating income, there was no indication that the trustees were going to sell the paintings and invest the proceeds in income producing investments. See Calder, 85 T.C. at 728 n.17.
[4] Recent cases have found that the general partner maintained too much control and therefore the partnership assets were includable in their estate under § 2036See Strangi v. Commissioner, 115 T.C. 478 (2000), aff’d in part, rev’d on § 2036 with remand to tax court, 293 F. 3d 279 (5th Cir. 2002), on remand, T.C. Memo 2003-145; see Kimbell v. Commissioner, 244 F. Supp. 2d. 700 (N.D. Texas 2003) (currently on appeal to the 5th Circuit).
[5] The discounts available to limited partnership interests include minority interest discounts, fractional interest discount, and lack of marketability discounts.  According to a BNA Daily Tax Report on January 13, 2003, if a partnership was created more than 6 months before the decedent’s death, the IRS Appeals office makes a valuation determination based upon the assets held by the partnership and typically finds a 30-40% discount for interests in a partnership with active assets, and 25-30% discount for interests in a partnership with passive assets.
A recent Leimberg Estate Planning Newsletter indicates that taxpayers can expect to see a 35 percent discounts replaced by discounts in the 25-30 percent range.  See Steve Leimberg’s Estate Planning Newsletter – Archive Message #600, October 29, 2003. <>.
[6] There is no federal estate tax on the first $1,000,000 of assets in a decedent’s gross estate.  This amount is scheduled to increase to $3,500,000 in 2009, sunset in 2010, and revert back to $1,000,000 in 2011.  See I.R.C. § 2010(c).

 Tax Year

 Exclusion Amount



 2004 - 2005


 2006 - 2008





 estate tax repealed



[7] A valuation expert should be consulted for valuation services.
[8] P.L.R. 9415007 (Gifts of limited partnership interests qualified for the annual exclusion because the general partner had a fiduciary duty in the partnership agreement and under state law.); P.L.R. 9710021; Tech. Adv. Mems. 9131006, 8611004.
[9] See U.S. v. Byrum, 408 U.S. 125 (1972) (holding that assets transferred were not included in the donor’s estate under § 2036(a)(2) because the donor was subject to a fiduciary duty).  But see P.L. 95-600 § 702(i)(1) (overruling Byrum with regard to voting stock).
[10]   See P.L.R. 9415007 (finding that gifts of the partnership interests qualified for the annual exclusion because the general partner had a fiduciary duty in the partnership agreement and under state law.) See Tech. Adv. Mem. 199944003 (finding that because under the partnership agreement the general partners are to uphold  a strict fiduciary duty toward the limited partners and the partnership, gifts of the partnership interests that the donor made to his children were gifts of present interests and qualified for the annual exclusion.
[11] If however there is only one donee with an income interest, then even if the trustee has discretion over distributions this qualifies as a present interest because no one else can receive the income.
[12] See also Perkins v. Commissioner, 27 T.C. 601, 604 (1956) (finding that because the beneficiaries, or the beneficiaries’ parent or duly appointed guardian, could at any time demand and receive as property all or part of the principal and accumulated income in the trust that this was a gift present interest).
[13] Craig Stephanson, CPA, and Jeff Bae, Esq., IRS Wins Round One in Court Battle Regarding Gifts of LLC Interests, Practical Tax Strategies, Feb. 2003.
[14] James L. Dam, “Family LLC Interest Gets No Gift Tax Exclusion,”  Lawyers Weekly USA, April 15, 2003; see also (under the “important documents” tab).
[15] It should be noted that if a donee has the right to transfer an income interest to a third party but the transferor retains the power to vote, this results in a lack of marketability and therefore a reduced valuation for transfer tax purposes.
[16] Craig Stephanson, CPA, and Jeff Bae, Esq., IRS Wins Round One in Court Battle Regarding Gifts of LLC Interests, Practical Tax Strategies, Feb. 2003.
[17] Estate planning attorney, Steve Akers, said that “from a business perspective, most business people putting together a partnership don’t want just a right of first refusal, where if they don’t buy [the interest] anybody can become a partner.” See, e.g., James L. Dam, “Family LLC Interest Gets No Gift Tax Exclusion,”  Lawyers Weekly USA, April 15, 2003.   Can also be found at under the “important documents” tab.
[18] Under the step transaction doctrine, if various steps are taken with the goal of tax avoidance all of the steps will be grouped together as one transaction.