7.6 Other Transfer Tax Issues

• Library: Limited Liability Companies in Virginia (Virginia CLE) (2017 Ed.)

7.6 OTHER TRANSFER TAX ISSUES

7.601 Annual Exclusion.

A. In General. If a member cannot require the LLC to redeem his or her interest at any time, qualifying for the annual exclusion under I.R.C. § 2503(b) may require that a member have the right to sell his or her interest to a third party after first offering to sell it to existing members or to the LLC itself. The adoption of the check-the-box regulations eliminates the problem of having the corporate characteristic of free transferability of interests.

B. Right to Assign Interest. The member may be given the right to sell his or her interest in distributions from the LLC to a third party after first offering to sell it to the other members at the price offered by the third party. The purchaser would be a mere assignee and would have no rights to participate in the management of the LLC. Nonetheless, the donee member should be treated as receiving a present interest equal in value to what a willing buyer would pay for the right to become a mere "assignee." In Technical Advice Memorandum 91-31-006, ⁶³ the IRS ruled that a donee limited partner had a present interest because that partner could assign his or her partnership interest subject to a right of first refusal. The IRS also ruled that because the general partner's power to control the distribution of income was subject to a strict fiduciary duty, it was not the equivalent of a trustee's discretionary authority to distribute or withhold income or principal and would not cause the gift to be a future interest.

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In Technical Advice Memorandum 97-51-003, ⁶⁴ the IRS ruled that donee limited partners did not have a present interest in a limited partnership because it was uncertain whether any income would be distributed to them since the general partners' duty was obviated by a provision allowing the general partners to retain funds for "any reason whatsoever," and they could not transfer or assign their interests or withdraw from the partnership and receive a return of capital.

Similarly, in Hackl v. Commissioner, ⁶⁵ the taxpayers were denied gift tax exclusions for gifts they had made of units of the company to their children and into a trust for their grandchildren because the Commissioner found there was no present interest to transfer. Their company had no current income and was configured so that the donors needed manager approval to withdraw capital; they also could not unilaterally dissolve the company. Similarly, in Price v. Commissioner, ⁶⁶ the IRS prevailed in denying annual gift tax exclusions on the grounds that they were gifts of future interests where interests were gifted in a limited partnership that did have substantial income, but the limited partners had no right to income distributions, could not withdraw their capital, and had restrictions on transfer and assignment. Because of the decisions in Hackl and Price and in order to ensure qualification for the gift tax annual exclusion, a donee should probably have a right to transfer his or her full membership interest to a third party after first offering it to the other members of the LLC at the same selling price and on the same terms as contained in a good faith offer by the third party.

7.602 Retained Interests or Powers.

A. Retained Enjoyment. I.R.C. § 2036(a)(2) requires the inclusion in the gross estate of property transferred by the decedent if the decedent retained the right to control the possession or enjoyment of the property or its income. The IRS has ruled that the value of transferred interests in a limited partnership is not includible in the decedent's gross estate under I.R.C. § 2036(a)(2) where the decedent was the sole general partner because the decedent occupied a fiduciary position with respect to the other partners and could not distribute or withhold distributions or otherwise manage the partnership for purposes unrelated to the conduct of the partnership

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business. Both Private Letter Ruling 94-15-007 ⁶⁷ and Technical Advice Memorandum 91-31-006 ⁶⁸ cited United States v. Byrum ⁶⁹ for the proposition that the general partner did not retain control within the meaning of I.R.C. § 2036(a) because of a fiduciary duty owed to the other partners. The IRS has been successful in including assets transferred to a limited partnership in the transferor's estate under I.R.C. § 2036(a)(1) and (2), ⁷⁰ but good practice in establishing and administering the limited partnership or LLC can minimize the risk of inclusion. Many of the cases in which the IRS...