Family LLCs (FLLCs) and/or Family Limited partnerships’ (FLLPs) have long been popular devices to use when making intra-family gifts (note the terms are used interchangeably below). They are easy to understand and administer, and require very little reporting at the state level, unlike a corporation. They are especially valuable and popular because the parent who creates the FLLC and then gifts the FLLC units to children, grandchildren or trusts established for their benefit, often remains in control as the FLLC’s manager, thus retaining the right to make investment decisions and decide when to make distributions from the FLLC to its members.
Recent changes, however, make transfers and value realization more difficult, especially in light of 2017’s Powell v Commissioner decision, which now allows the IRS to attempt to include the value of the transferred FLLC units in the parent’s taxable estate. Powell, though transformational, is not the first judgement to give families and estate planners cause for concern. The following is a synopsis of Tax Court decisions to consider as modern FLLCs are structured and what to consider with Gifts of LLC Interests.
LLC Precedents
• Powell v. Commissioner
In Powell, the mother owned a non-controlling 99 percent limited partnership at the time of her death. Her sons owned the 1 percent controlling general partner interest. The Tax Court held that despite being the limited partner the mother could act in conjunction with the general partner either to make distributions or to liquidate the partnership, thus causing $10 million of partnership assets to be included in the mother’s taxable estate at their fair market value.
The Tax Court focused on the fact that the son-general partner held his mother’s durable power of attorney, and as such he had a fiduciary duty to her, which thus constrained his independence as the general partner.
• Senda v. Commissioner
In Senda, parents created an LLC to hold highly appreciated marketable stock. On the same day, the parents then gifted some of the LLC units to their children (or trusts for their benefit). The parents tried to extract more value and claimed valuation discounts because the subject of their lifetime gifts were (i) minority, non-controlling, interests in the LLC (ii) which were not readily marketable due to the transfer restrictions contained in the LLC’s operating agreement.
The Tax Court found that the interests were transferred at the same time that the LLC was funded with marketable securities. Collapsing those two steps, the Tax Court found that the subject of the gift was not the LLC units but was the appreciated marketable stock. The Tax Court supported the IRS’s position that the underlying assets held in the LLC, appreciated stock, were the actual subject of the gift, not the “discounted” LLC units. As a result, the Tax Court ignored the application of valuation discounts and assessed a gift tax, penalties and interest on the underpayment of the gift tax caused by the gift of appreciated marketable securities.
• Hackl v. Commissioner