When it comes to the tax cost of a lifetime gift of property, estate planners often focus on the gift taxable value of the transferred asset and, to that end, on the asset's form. In the international context, the focus on form can be even more important. Rules that merely evaporate discounts in the domestic context actually can turn non-taxable gifts into taxable ones in the international context.

So, the critical question becomes: how do we structure international gifts to ensure they're not taxed?

Rules and Realities

The basic rule is this: An individual who is neither a citizen nor a resident of the United States for U.S. estate and gift tax purposes (let's call them NC/NRs) is subject to U.S. gift tax only on the transfer of real or tangible personal property that has a U.S. situs.1

But how it plays out can get complicated. If, for example, an NC/NR parent wants to transfer a valuable painting in her Upper East Side New York City apartment to her child, who intends to hang it in his TriBeCa loft, the gift would trigger U.S. gift tax. By contrast, if the same painting were owned through a corporation, and the NC/NR were to transfer the corporation itself to her child, this transfer would not be subject to U.S. gift tax, because the interest in the corporation is an intangible asset, and therefore, not subject to U.S. gift tax.

With such formalistic rules, it's easy to fall under the impression that a paper trail, and nothing more, can protect these kinds of gifts (let's refer to them as “international gifts”) from U.S. taxation. But it's critical to realize that these international gifts are subject to the same principles and doctrines that govern every other gift.

In particular, the indirect gift doctrine and the step transaction doctrine have the same application and pose the same risks in the international context as they do everywhere else. A few recent decisions of the Tax Court highlight the importance of these doctrines and remind us of the importance of substance, as well as form, in any structured international gift transaction.

Gift Taxation of NC/NRs

The first step in assessing the potential gift tax cost of a transaction is to determine whether the donor qualifies as an NC/NR. The easier element of this definition is whether a person is a U.S. citizen, as the Internal Revenue Code does not provide its own definition and instead relies on general U.S. immigration law (that is to say, someone born in the United States, naturalized in the United States, or acquiring citizenship under applicable immigration law).

The more difficult determination is whether a person is a non-resident for gift tax purposes. Unlike the U.S. income tax system, which generally determines residency based on the relatively bright-line “green card” and “substantial presence” tests, there is no objective standard for determining whether a person is considered a U.S. resident for gift tax purposes. Rather, this definition basically incorporates the common law principle of domicile. That is to say, a person is considered a U.S. resident for gift tax purposes if he or she is living in the United States, even for a brief period of time with no definite present intention of leaving.2 The Internal Revenue Service considers various factors to determine whether a person has the requisite intent to remain, including the location of the person's family and property, to where the person is registered to vote and where he holds a drivers license.

Scope of Taxation

While U.S. citizens and residents are subject to gift taxation with respect to the gratuitous transfer of any property, wherever situated, NC/NRs are subject to gift tax only on transfers of U.S.-situs real property and tangible personal property. Indeed, transfers of intangible assets by non-citizen non-residents are expressly excluded from gift tax.3

Importantly, while U.S. citizens and residents are granted a $1 million lifetime exemption from gift taxes, NC/NRs have no similar exemption. NC/NR spouses are also ineligible to elect gift splitting.

But NC/NRs do have an annual exclusion for gifts of present interests in property (currently $13,000).

So, for example, let's say a U.K. citizen who resides in the United Kingdom would like to transfer a vacation home in New York to his two children. If he transfers the home to his children, he'll be subject to gift tax because this is a transfer of U.S.-situs real property. He will have the benefits of the annual exclusion from gift taxes (currently $13,000 per donee), but the balance of the value will be taxable without the benefit of any lifetime exemption from gift taxes.

On the other hand, a transfer of his U.S. stocks or Treasury notes would not attract any gift tax because they are intangible assets.

While the IRS seems to have reserved the right to challenge whether an interest in a partnership will be treated as intangible property (as opposed to an undivided interest in the underlying property),4 the more accepted view, at least among practitioners, seems to be that interests in partnerships and limited liability companies (LLCs) should be treated as intangible for purposes of the gift tax rules. (See “Calling for Clarity On NRA's Partnership Situs,” p. 36.)

Transforming Property Transferred

In light of the gift tax framework applicable to NC/NRs, the opportunities for structuring tax-free international gifts are plain. For example, a transfer by an NC/NR of tangible personal property can be exempted from gift taxes by having the transfer occur outside of the United States. Alternatively, an NC/NR can form a corporation, LLC, or partnership and transfer ownership of U.S. real or tangible personal property to the new entity. The stock, LLC or partnership interests are considered intangible assets, despite the tangible nature of their underlying assets, and therefore the transfer of such interests to a child or other intended donee should be exempt from gift tax.5 Alternatively, the NC/NR could give cash to the donee6 and the donee could use this cash to buy U.S.-situs property. But note: Taxpayers should be aware that the IRS could argue that a gift of cash is in fact a disguised gift of U.S.-situs property.

In the 1963 Tax Court case Geoffrey C. Davies,7 the petitioner's father, an NC/NR, decided he wanted to keep real property he owned in Honolulu within the family. He discussed with his son (the petitioner) the possibility of having the son buy the real property from his father, but the son didn't have enough money. To solve this problem, the father agreed to sell the property to his son in exchange for a note secured by a mortgage on the property. Because petitioner was having difficulty putting together the funds necessary for the down payment, the father deposited 5,000 pounds sterling into petitioner's British bank account, with the understanding that this amount would be used by the son to make the down payment on the real estate purchase.

Over the following year, the balance of the mortgage was paid in a similar manner, with the father depositing funds into the petitioner's British bank account every month, followed a week or two later by the son drawing a check on the account for the same amount that was deposited and sending it back to his father to be applied against the remaining principal on the note.

After the father died a year later, the IRS sent a deficiency notice to the son, asserting that the transfer of the Honolulu real estate was a taxable gift from the father to the son. The IRS argued that the father's actions, when considered in total, were effectively a transfer of U.S. real estate, which then as now would have been subject to U.S. gift taxes. The petitioner argued in response that his father's transfers to him were simply cash gifts made in Britain, where his father was domiciled, and therefore should not trigger any gift tax consequences.

The court ruled that the amount the father transferred to his son to pay the down payment on the real estate was equivalent to a transfer of U.S. real estate, and therefore subject to U.S. gift tax, because the money was received on the express condition that it be used for that purpose. But the court did not find that the father's subsequent payments to the son, each of which was used by the son to promptly pay down the mortgage, were effectively a gift of the father's real estate. The court felt comfortable coming to this conclusion because in contrast to the down payment, the court could not identify any pre-arranged agreement or condition that the subsequent transfers were to be used by the son to make the mortgage payments.

While not explicitly cited, the ruling seems to have been based on something akin to the step transaction doctrine. With the money for the down payment, the court found that something like a binding commitment existed, so the steps of the cash gift and the subsequent down payment could be collapsed. Regarding the later cash gifts, the court found that, at a minimum, no binding commitment existed. It's unclear whether the court would have come to the same conclusion had it applied an “end result” or “interdependence” test; the alternative tests of the step transaction doctrine.

The 1948 case of De-Goldschmidt-Rothschild v. Commissioner provides an example of a similar attempt at gift structuring that nonetheless resulted in application of the U.S. gift tax.8 In De-Goldschmidt-Rothschild, the taxpayer was a French citizen who came to the United States temporarily and during this time held about $300,000 in U.S. securities. While in the states, she was advised by her cousin, a banker, that it would be wise to transfer some of these securities to her two children, who had both announced their intentions to remain in the United States.

The taxpayer decided to create two trusts, one for each child, and to fund each with about $100,000 in securities. But before this transfer was made, she was advised to convert the securities into U.S. bonds and Treasury notes, which at the time were exempted from U.S. gift tax. She went through with this planning and transferred the gift tax-exempt assets to the trusts. Within eight months, the trustee of the trusts had disposed of the U.S. bonds and reacquired higher yielding marketable securities (the transfer of which would not have been exempt from gift tax at that time) in their place.

The IRS asserted a deficiency against the taxpayer, claiming that the U.S. bonds and Treasury notes initially transferred to the children's trusts could not be considered gift tax-exempt assets because they were made with the intention that such assets would simply be resold and used to buy taxable securities.

The court agreed with the IRS, ruling that the transfer would be treated as one of the gift-taxable securities. The court focused on the fact that the taxpayer had knowledge that the trustee was going to sell the government notes soon after the trusts were funded, as this was in line with the trust company's policy of diversifying assets. The court also noted that the trustee could not transfer trust assets without the taxpayer's consent and that the taxpayer had the right to remove a trustee, indicating that the trustee was in fact under the control of the taxpayer.

The court found that combined, these facts indicated a pre-arranged plan, set up solely for obtaining tax exemption and not for any real investment purpose, and the existence of this plan negated any gift tax-exemption on the initial transfer of the U.S. bonds and Treasury notes to the trusts. As in Davies, the ruling in this case has tones of the step transaction doctrine. In De-Goldschmidt-Rothschild, however, the court seems to have been applying something like an “end result” test, and therefore collapsed a transaction that may well have survived both the “binding commitment” and “interdependence” tests.

Domestic Application

Davies and De-Goldschmidt-Rothschild are the markers by which to measure whether a structured international gift might avoid gift tax.

Practitioners should be aware that U.S. citizens and residents often employ in the domestic context some of the very same techniques as those used in structuring international gifts. In the domestic context, one of the goals is to obtain a valuation discount on the property transferred. For example, in the domestic context property may be “transformed” into stock or LLC interests burdened with marketability and liquidity restrictions, which may support valuation discounts. As we are all too aware, these techniques sometimes are not respected by the IRS and the courts, leading to a disregard for valuation discounts and a gift-taxable value higher than what is claimed by the taxpayer.

Practitioners should be aware that the arguments used by the IRS to attack the transformation of property in the domestic context apply just as well to the transformation of property in the context of structured international gifts. In the latter context, however, what's lost is not a valuation discount, but a complete exemption. For this reason, international practitioners should pay special attention to the domestic cases in this area and heed the warning signals when structuring international gifts. In particular, the indirect gift doctrine and the step transaction doctrine pose special risks to the structured international gift.

The dangers that the indirect gift doctrine and step transaction doctrine pose to poorly structured gift transactions are exemplified by the recent case of Heckerman v. United States.9 The taxpayer in Heckerman sought to transfer certain gifts to his two minor children. To facilitate this process and ensure that minimal gift tax was imposed, the taxpayer established trusts for each of his children. He then established three LLCs, one being an umbrella LLC that acted as the sole owner of the other two LLCs. On Jan. 11, 2002, the taxpayer transferred $2.85 million in mutual funds to one of the subsidiary LLCs. The taxpayer also transferred interests in the umbrella LLC to the children's trusts, signing gift documents stating that the gifts were also effective on Jan. 11, 2002. The taxpayer filed gift tax returns for the transfer of the LLC units, taking a 58 percent discount for the units' lack of marketability.

The IRS disagreed with the taxpayer's assessments in regards to the $2.85 million in mutual funds. The IRS argued that because the taxpayer could not establish that the cash was part of the LLC when the units were transferred to the children's trusts, the taxpayer could not establish that an interest in an LLC, as opposed to cash, was the property transferred. The IRS argument would effectively negate any claimed minority or marketability discounts as a result of the cash being held in LLC units.

Alternatively, the IRS argued that the taxpayer's actions in funding the LLC and then gifting the LLC units on the same day constituted an integrated transaction under the step transaction doctrine, requiring treatment as if the cash, and not the LLC units, was transferred directly to the children.

The court agreed with the IRS on both theories. Regarding the indirect gift doctrine, the court noted that the key issue was whether the taxpayer could show that he gifted the LLC units to the children subsequent to the date that the $2.85 million was transferred to the LLC. Because the evidence showed that the taxpayer gifted the LLC units on Jan. 11, 2002, the same date that the LLC was funded with cash, the court ruled that the taxpayer could not disprove the assertion (as was his burden) that the transfer of cash to the LLC was made subsequent to the transfer of the LLC interests to the children.

Alternatively, the court found that the taxpayer's actions constituted an integrated transaction under the step transaction doctrine. The court laid out the three tests typically used to determine when the step transaction doctrine applies: (1) the “binding commitment” test, (2) the “end result” test, and (3) the “interdependence” test. The court found that both the “end result” and “interdependence” tests were satisfied. The “end result” test was met because statements by the taxpayer and his financial advisor clearly indicated the subjective intent to use the scheme in question to achieve the ultimate result. The “interdependence” test was met because the record clearly showed that the taxpayer would not have transferred his money into the LLC were it not for his intent to subsequently transfer LLC units to his children. Because the step transaction doctrine applied, the court treated the gifts as transfers of the underlying assets, disallowing any claimed discounts as a result of the assets being in an LLC.

Another example of pitfalls to avoid when structuring a gift comes in Linton v. United States.10 The taxpayers in Linton were, similar to the taxpayer in Heckerman, attempting to reduce potential gift taxes by using an LLC to transfer assets to their children at a reduced value. To that end, the taxpayers formed an LLC and on Jan. 22, 2003, executed the necessary documents to transfer a mixture of real property, cash, bonds and certain securities to the recently created LLC. On the same date, the taxpayers also executed documents transferring certain percentage interests in the LLC to trusts set up for the benefit of their children, but left these documents undated. Months later, the taxpayers' attorney, who had prepared all the various documents, filled in Jan. 22, 2003, as the date for these documents. On their gift tax return for 2003, the taxpayers took a 47 percent discount for the value of the transferred LLC interests based on the lack of marketability and minority status of the interests.

The IRS objected to these discounts, and moved for summary judgment. The IRS argued that any discounting was improper because the taxpayers had made what amounted to an indirect gift, and alternatively that the transfers to the LLC and subsequent gifts of the LLC interests to the trusts were integrated under the step transaction doctrine.

This court ruled in favor of the IRS, finding validity in both of the IRS' arguments. In holding that the indirect gift doctrine applied, the court ruled that the taxpayers had not presented sufficient evidence to show that the LLC interests were funded sufficiently before the interests were transferred to the children's trusts. The court focused on the documents that were executed by the taxpayers, finding that these indicated that the transfer of the LLC interests to the children's trusts were made before or at least simultaneously with the funding of the LLC interests on Jan. 22, 2003.

Additionally, the court agreed with the IRS' argument that even if the LLC was funded before the transfers of interests to the children's trusts, the taxpayers had made indirect gifts under the step transaction doctrine. The court found that all three tests under the step transaction doctrine were satisfied: (1) the “binding commitment” test, (2) the “end result” test, and (3) the “interdependence” test.

Furthermore, the court distinguished the taxpayers' situation from similar cases in which the step transaction was not applied. The court noted that in these previous cases the taxpayers had delayed the gifts of LLC interests until at least a few days after the funding of the LLC, and that the assets used to fund the LLCs in previous cases had been subject to some volatility in value during the time elapsed from funding until the transfer of the LLC interests. As a result, the taxpayers in these previous cases had been subject to “real economic risk” during the interim period between the funding and the transferring of the LLC units, which the court found lacking in the current case. Because there was no “real economic risk” as a result of the transfer of the assets to the LLC, the court felt comfortable ruling that the step transaction doctrine applied to the taxpayers' gifts and would negate any claimed discounts.


Aside from the general lesson that substance, rather than form, governs the tax results of a transaction, the recent cases provide a number of more specific lessons about structuring international gifts. One of the key lessons is the importance of being significantly attuned to the applicable dates for the initial funding and subsequent transfer of both interests in corporations and interests in LLCs. As demonstrated in the recent case law, there is a substantial risk that if a taxpayer simultaneously funds a company and gifts interests in that company, the indirect gift doctrine may be applied to treat the transaction as a gift of the underlying property to the donee, negating discounts in the domestic context and potentially transforming a non-taxable gift into a taxable one in the international context. To avoid this issue, practitioners should be acutely aware of the need to fund the company some time prior to the gifting of LLC interests, and that the appropriate length of time to avoid an IRS attack may depend on the nature of the underlying assets.

Another key lesson is to focus on the dangers that the step transaction doctrine presents for international gifts. In both of the recent rulings mentioned, the court emphasized that even if the taxpayers could have shown that the LLCs were funded before the transfer of LLC interests to the children, the step transaction doctrine would nonetheless have been applied, resulting in disregard of the gifts form, the ultimate result being that the taxpayers would be taxed as if they had simply given the underlying assets to their children.

To avoid the potential application of the step transaction doctrine, the best practice for estate planners structuring international gifts might be to advise NC/NR clients to hold U.S.-situs assets in intangible solutions from the inception. Then, a subsequent transfer of the intangible is far removed from the initial transfer of property to the holding company. If this is not possible, practitioners should remember that the interim time between funding of the holding company and the gift of interests in the company must involve some “real economic risk” to the taxpayers. While the courts have not done much to define this concept, it is clear that the length of this interim period and the volatility of the underlying assets are the two key factors in determining whether any “real economic risk” exists.

The authors thank Liam D. Crane, an associate in the New Haven, Conn. office of Withers Bergman LLP, for his contributions to this article.


  1. It is important to mention that for these purposes the Treasury department considers cash a tangible asset, which can lead to unexpected and sometimes counterintuitive results.
  2. See Treasury Regulations Section 25.2501-1(b).
  3. Special gift tax rules can apply to certain types of expatriates. See Internal Revenue Code Sections 2501(a)(3) and 2801.
  4. The Internal Revenue Service's position in Revenue Procedure 2009-7, 2009-1 IRB 226 Section 4.01(27), is that it will not rule on whether a partnership interest will be treated as intangible property for U.S. gift tax purposes.
  5. In this regard, while there may be some risk that the IRS would seek to disregard a single-member limited liability company (LLC), the Tax Court recently ruled that transfers of interests in a single-member LLC treated as a disregarded entity under the check-the-box regulations were to be valued for gift tax purposes as transfers of interests in the LLC. Suzanne J. Pierre v. Commissioner, 133 T.C. No. 2 (2009). This ruling suggests that a single member LLC should be respected for purposes of determining the nature of the asset transferred in an international gift.
  6. Because the IRS considers cash tangible personal property, any gift of cash should occur outside of the United States. A series of recent private letter rulings suggest that a check drawn on a non-U.S. bank should be sufficient to satisfy this requirement. See Private Letter Rulings 200748008 and 200340015.
  7. Geoffrey C. Davies, 40 T.C. 525 (1963).
  8. De-Goldschmidt-Rothschild v. Comm'r, 162 F.2d 975 (2d Cir. 1948), aff'g 9 T.C. 325 (1947).
  9. Heckerman v. United States, 104 AFTR 2d 2009-5551 (W.D. Wash 2009).
  10. Linton v. U.S., 104 AFTR 2d 2009-5176 (W.D. Wash 2009).

N. Todd Angkatavanich, far left, is a partner, and Edward A. Vergara is an associate, in the New York, Greenwich and New Haven, Conn. offices of Withers Bergman LLP An NC/NR's transfer of tangible personal property can be exempted from gift taxes if the transfer occurs outside of the United States. To avoid IRS attack, be sensitive to the dates of the initial funding and the subsequent transfer of interests in a corporation and an LLC.