Academic journal article Fordham Journal of Corporate & Financial Law

Gifts of Family LLC Units in a Post-Hackl Era: Present Interests or Future Interests?

Academic journal article Fordham Journal of Corporate & Financial Law

Gifts of Family LLC Units in a Post-Hackl Era: Present Interests or Future Interests?

Article excerpt

INTRODUCTION

A.J. and Christine Hackl had eight children, twenty-five minor grandchildren, and a significant accumulation of wealth, which they desired to give to younger members of the family.1 In order to increase their long-term growth investments2 and transfer a portion of their property to their descendants, the Hackls invested in multiple tree farms.3 In order to ease this transfer, the Hackls used an organization commonly referred to as a family limited liability company ("family LLC")4 to own and operate the tree farms.5

The operating agreement for the Hackls' family LLC was notably restrictive and provided that: 1) the family LLC was to be managed exclusively by a manager, initially A.J., who would "serve for life, or until resignation, removal, or incapacity;"6 2) cash distributions could only be made with the approval of the manager;7 3) no member could withdraw his capital contribution without approval of the manager;8 4) manager consent was necessary for a member to withdraw from the family LLC;9 and 5) without written consent from the manager,10 no member could "transfer, assign, convey, sell, encumber or in any way alienate all or any part of the Member's Interest."11

The Hackls gifted units of the family LLC to their eight children and twenty-five grandchildren.12 In 1996, they gave 500 voting and 750 non-voting units to their children and 31,250 non-voting units to a trust that was established for the benefit of their grandchildren.13 The Hackls filed gift tax returns, which reported the transferred units as "split gifts."14 In these returns, they claimed the annual exclusions available in section 2503(b).15 In April, 2000, the IRS claimed both that the annual exclusion did not apply to the gifts made in 1996 and that A.J. and Christine had tax deficiencies in their federal gift taxes of $ 309,950 and $ 309,866, respectively.16

Upon receiving the IRS's notice of deficiency, the Hackls filed for a redetermination of the matter from the U.S. Tax Court.17 The sole issue before the Tax Court was whether the gifts of the family LLC units were gifts of a present interest, which would allow the benefit of the annual exclusion, or gifts of a future interest, leaving the Hackls with a tax deficiency.18 The Tax Court held that the operating agreement "foreclosed the ability of the donees presently to access any substantial economic or financial benefit" derived from owning the units of the family LLC.19 Further, the Tax Court expressed that there was no present interest gift of income resulting from ownership of the units because 1) the property held by the family LLC was held for long-term growth, thus there was no plan for the investment to produce short-term income, and 2) the manager had unfettered discretion to give distributions if there was any income.20

I. RELATED LAW

A tax is imposed on gifts of property.21 The scope of this tax is quite broad-it 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."22

A taxable gift is the total amount of the gift less any applicable deductions.23 However, an annual exclusion is allowed for the first $10,000(24) of present interest gifts per donee.25 Thus, taxable gifts, as defined in 26 U.S.C. section 2503(a), do not include the first $10,000 of gifts given to each donee each year unless the gifts are not present interests.26 A present interest is "[a]n unrestricted right to the immediate use, possession, or enjoyment of property or the income from property."27

Many cases have applied the definition of a present interest.28 The standard applied to determine whether a gift is a present or future interest is summarized in Fondren v. Commissioner29 Vested rights alone do not create a present interest; instead, it is necessary that the donee receive a "substantial present economic benefit" from the gift.30 In other words, it is necessary to determine at what point enjoyment of the property begins. …

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