Taxpayer entitled to charitable deduction for gifts of L.L.C. units.

• Author: Beavers, James A.

CHARITABLE CONTRIBUTIONS

Taxpayer Entitled to Charitable Deduction for Gifts of LLC Units

The Ninth Circuit held that a taxpayer was entitled to a charitable deduction for gifts of LLC units to two charitable foundations that were transferred to the foundations when the IRS increased the value of the LLC units on audit.

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Background

After Anne Petter inherited a large amount of UPS stock, she set up a complex estate plan designed to give some of her wealth to charity and as much of her stock as she could to two of her children, Donna and Terry, without having to pay gift tax. As part of the plan, Petter transferred the stock to a family LLC in return for interests in the LLC, and she set up separate trusts for both Donna and Terry. Petter transferred membership units in a family-owned LLC partly as a gift and partly by sale to the two trusts and coupled the transfers with simultaneous gifts of LLC units to two charitable foundations. The transfer agreements included:

* A dollar formula clause, which assigned to the trusts a number of LLC units worth a specified dollar amount and assigned the remainder of the units to the foundations; and

* A reallocation clause, which obligated the trusts to transfer additional units to the foundations if the value of the units the trusts initially received was finally determined for federal gift tax purposes to exceed the specified dollar amount.

Petter filed a gift tax return to report the transfers in 2002. The return disclosed the allocation and reallocation clauses. It further disclosed that the value of the LLC for determining the amount of the transfers reported was based on the fair market value of the underlying assets of the LLC with a 46% nonmarketability discount and a 13.3% net asset value adjustment applied.

On audit in 2005, the IRS concluded that the LLC units had been greatly undervalued. Petter and the IRS eventually agreed that the value of the LLC units was slightly lower than the amount the IRS initially claimed. Under the transfer agreements, this resulted in the transfer of additional LLC units from the trusts to the charitable foundations.

Petter sought to take a deduction for the additional shares given to the charitable foundations. However, the IRS refused to allow her to take the deduction, claiming that the dollar formula clauses were void as against public policy, and the clauses caused the gifts to be subject to a condition precedent under Regs. Sec. 25.2522(c)-3. Petter challenged the IRS's determination in Tax Court, which held that the transfers were not void as against public policy and were not gifts subject to a condition precedent (Estate of Petter, T.C. Memo. 2009-280).

The IRS appealed the decision to the Ninth Circuit, where it abandoned the public policy theory and argued only that the adjustment...