Check-the-box regs. do not affect the valuation of LLC interests.

• Author: Beavers, James

[ILLUSTRATION OMITTED]

The Tax Court held that limited liability company (LLC) interests transferred by a taxpayer into trusts set up for the benefit of her children should be valued as transfers of LLC interests and not as transfers of the underlying assets owned by the LLC.

Background

The taxpayer, Suzanne Pierre, received a $10 million gift from a wealthy friend in 2000. Pierre, who was in her eighties, wished to use some of the gift to provide support for her son and granddaughter but wanted to keep the family wealth intact. To achieve these goals, later that year she set up a valid single-member New York LLC, the Pierre Family, LLC, which was treated as a disregarded entity under the check-the-box regulations (Regs. Secs. 301.7701-1 through -3), and separate trusts for her son and granddaughter. She then transferred $4.25 million in cash and publicly traded securities to the LLC and subsequently transferred a 9.5% membership interest in the LLC to each of the trusts by gift and sold each trust a 40.5% interest in the LLC in return for promissory notes.

Pierre filed a gift tax return for 2000 that reported the gifts of the membership interests to the trusts. When valuing the transfers for federal gift tax purposes, she applied substantial discounts for lack of marketability and control and therefore paid no gift tax on the transfers.

On examination, the IRS determined that the entire amount of the 9.5% interests transferred by gift should be treated as gifts of the LLC's underlying assets because, under the check-the-box regulations, the LLC was classified as a disregarded single-member entity. This treatment eliminated the valuation discounts, resulting in a much higher gift value for gift tax purposes. It also found that the value of the 40.5% interests, less the value of the promissory notes given by the trusts, should be treated as gifts.

Pierre challenged the IRS's determination in Tax Court. She argued that state, not federal, law determines the nature of a taxpayer's interest in transferred property. She further argued that, under New York law, a membership interest in an LLC is personal property and a member has no interest in specific property of the LLC. Therefore, she properly valued the gifts as gifts of an LLC interest rather than gifts of the LLC's assets.

The Tax Court's Opinion

The Tax Court held that the determination of the value of the LLC interests transferred by Pierre should be made under state law. Because under...