Tax Law Update 2011-03-01 (1)Tax Law Update 2011-03-01 (1)

Ninth Circuit remands case to determine when gift was intended to be made — In 2009, the District Court for the Western District of Washington granted the Internal Revenue Service's motions for summary judgment against William and Stacy Linton in Linton v. United States, C08-227Z, 2009-2 USTC para. 60,575 (July 1, 2009). (For more information about that decision, see “Tax Law Update” in the August 2009 issue of Trusts & Estates, p. 9.) The U.S. Court of Appeals for the Ninth Circuit recently overturned that decision. Linton v. U.S., 107 AFTR 2011-xxxx (9th Cir. 2011).

In December 2002, Bill Linton formed WFLB Investments, LLC. On Jan. 22, 2003, (1) Bill transferred 50 percent of the limited liability company (LLC) to Stacy; (2) he conveyed securities and real estate to the LLC; (3) Bill and Stacy signed but didn't date trusts for each of their four children; and (4) Bill and Stacy signed but didn't date documents transferring LLC interests to each of the trusts. Later, the Lintons' attorney filled in the missing date on the trust and transfer documents as Jan. 22, 2003. However, the Lintons had discussed Jan. 31, 2003 as the transfer date with their accountant and the attorney.

The Lintons claimed on their gift tax returns that a 47 percent valuation discount was applicable to the gifts. The IRS denied the discounts, claiming that the Lintons' gifts weren't direct gifts of LLC interests, but were indirect gifts of the assets contributed to the LLC. The Lintons paid the tax deficiency and sued for a refund, and the IRS moved for summary judgment.

The district court granted summary judgment to the IRS, holding that no genuine issue of material fact existed as to the Lintons' subjective intent or the contemplated and actual sequence of events. Under state law, it reasoned that the LLC didn't exist until it owned property. Therefore, the creation and funding of the LLC and the purported transfers of LLC interests all occurred on the same day. Additionally, the district court granted summary judgment to the IRS based on the alternative theory that the gifts were indirect gifts of the property transferred to the LLC based on the step-transaction doctrine. The district court also denied summary judgment to the Lintons, holding that their “failed gift” argument wasn't convincing.

The Ninth Circuit reversed both summary judgment decisions that had been issued in favor of the IRS and remanded the case to the district court. First, the Ninth Circuit reviewed the requirements for a completed gift under state law, which are: (1) intention of the donor to give, (2) subject matter capable of delivery, (3) delivery, and (4) acceptance by the donee. The critical issue for the Ninth Circuit was determining when the Lintons intended to make the gift. Unfortunately, because the documents transferring the interests were initially undated, the court had to determine the applicable date. The Ninth Circuit found that the Jan. 22, 2003 date that the attorney had later filled in on the trust and transfer documents wasn't determinative. According to the court, the evidence had to be analyzed to determine when the Lintons demonstrated an objective manifestation of their intent to make the gift complete. As a result, the Ninth Circuit remanded the case to the district court to decide this issue.

The Ninth Circuit also held that the IRS wasn't entitled to summary judgment based on the application of the step-transaction doctrine and remanded the issue to the district court. The step-transaction doctrine applies if any of three tests are met: the end result test, the interdependence test and the binding commitment test. The court held that even if the end result test applied to condense the steps into a single transaction, the Lintons' gift would still be of LLC interests rather than the underlying assets and the tax result wouldn't change. The interdependence test didn't apply because funding the LLC was a separate transaction with an independent purpose from gifting LLC interests. Lastly, there was no binding commitment to make the gift once the LLC was funded so the binding commitment test didn't apply either.

Lastly, the Ninth Circuit held that the Lintons weren't entitled to summary judgment based on their “failed gift” theory. The Lintons had pointed to a provision of the LLC agreement that required a member's capital account to be increased by the value of capital contributions made to the LLC. They had argued that if they had transferred property to the LLC after they had attempted to make gifts of LLC interests, the property transferred to the LLC would be credited to their own capital accounts, not the capital accounts of the trusts for their children, and then in fact, no gift would actually have ever been made, despite their intentions. The Ninth Circuit found this technical argument unconvincing in light of the substance of the transaction and the Lintons' intent.

The Linton case shows the importance of carefully timing transactions and adhering to formalities — otherwise the characterization of the transaction is left to the courts.

Tax Court holds estate isn't entitled to discounts on multiple fractional interests in same property subject to Internal Revenue Code Section 203 — In Estate of Adler v. Commissioner, T.C. Memo 2011-28 (Jan. 31, 2011), the Tax Court agreed with the IRS that the estate had incorrectly valued the decedent's interest in a ranch by applying fractional interest discounts.

Axel Adler owned approximately 1,100 acres known as the Rancho Aquila property in Carmel, Calif. In 1965, he gave an undivided one-fifth interest in the property to each of his five children. However, in the deed, he reserved for himself the full use, control, income and possession of the property. After making the gift, Adler continued to live on the property and paid all expenses. None of the children resided there or interfered with his use in any way. Later, in 1991, one of his children deeded her one-fifth interest back to Adler. So at the time of his death, Adler owned a one-fifth interest in the property and his other four children owned the remaining four-fifths.

The estate had included in Adler's gross estate a one-fifth interest in the property subject to a 32 percent marketability discount and a 16 percent minority interest discount. On Schedule G to Form 706, the estate also reported the value of the other four-fifths interest, each separate one-fifth interest subject to a 22 percent marketability discount and 16 percent minority interest discount (it's not clear from the opinion why the marketability discount was 32 percent, versus 22 percent for the interest owned by Adler, versus the interests owned by his children).

The Tax Court held that IRC Section 2036 (which includes the value of property transferred by a decedent who retains the possession or enjoyment of or the right to the income from such property in the decedent's gross estate) treats a transfer of the property subject to a decedent's right to possession or enjoyment as actually occurring at death, not during life. As a result, the Tax Court held that (1) Adler was to be treated as if he had retained the entire interest in the property for his life and transferred the four interests to his four children at his death, and (2) 100 percent of the value of the children's interests and his interest was includible in Adler's gross estate, without any valuation discount. The court distinguished this case, in which Adler retained full control of the property, from a an earlier case (Estate of Mellinger v. Comm'r, 112 T.C. 26 (1999)), in which blocks of stock owned by a surviving spouse and a qualified terminable interest property trust for her benefit were valued separately because the surviving spouse didn't “possess, control or have any power of disposition over” the stock in the trust.

Value of residence included in decedent's estate under IRC Section 2036 … again — In Estate of Adelina Cheng Van v. Comm'r, T.C. Memo 2011-22 (Jan. 26, 2011), the Tax Court held that a residence purchased by Adelina Cheng Van was includible in her gross estate under Section 2036. Van had arranged for the purchase of the house from her boyfriend for her daughter's family (the Hus) in 1988. From the court's opinion, it appears that Van signed the purchase documents — a sale agreement and a secured promissory note — and the house was titled in her name. But the Hus supplied the purchase money for the initial down payment and the ongoing promissory note payments.

Over the years, title to the house was transferred to and among various parties, including the Hus' children (Van's grandchildren). Van resided in the home from the time of purchase until her death, without paying rent. The last transfer of title was made in 1999, when Van transferred title to the house from herself as trustee of her own revocable trust to her daughter and three granddaughters. She died the following year.

The estate claimed that Van never owned the house. Instead it argued that she merely took title to the home as the Hus' agent. Van worked in the real estate business professionally and had orchestrated other real estate purchases for the Hus. But Van took title to this home in her own name, which she didn't do with other deals. In addition, the Tax Court wasn't convinced that the Hus could have title under California law, which provides that the owner of the legal title to property is presumed to be the owner of the full beneficial title. Nor did it find that the home was subject to a resulting trust in favor of the Hus.

Since the Tax Court concluded that Van originally owned the home, her transfer in 1999 of the home followed by her continued use, possession and enjoyment of the home until her death caused the value of the home to be includible in her estate under Section 2036.

IRS publishes estate tax data tables for 2007 death year — On Feb. 4, 2011, the IRS published on its website six estate tax tables summarizing data gathered from Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, filed for decedents who died in 2007.

Two of the tables contain information on selected assets, deductions and calculation items, which are classified by tax status and size of gross estate (valued for estate tax purposes or on date of death). A third table contains information on gross and net estate tax and state death tax deductions classified by the decedents' state of residence. Two tables provide statistics on total gross estate and net estate tax classified by gender, age and marital status. The final table includes statistics on charitable bequests with items classified by marital status and gender.