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Saturday, August 01, 2009


Oftentimes, taxpayers contribute assets to partnerships or LLCs, and then make a gift of ownership interests in the partnership or LLC and seek to apply a valuation discount to the gift. A recent District Court case voided the application of the discounts through the use of the step transaction doctrine.

In the case, there was some uncertainty whether the gift of interests in an LLC occurred simultaneously with the contribution of assets to the LLC, or sometime after. Nonetheless, the court addressed what result would occur even if the funding to the LLC occurred prior to the gift of LLC interests.

The court noted that there are three different tests under which the step transaction can be applied. The binding commitment test, which is the narrowest alternative, collapses a series of transactions into one “if, at the time the first step is entered into, there was a binding commitment to undertake the later step.” The end result test stands at the other extreme and is the most flexible standard, asking whether the “series of formally separate steps are really pre-arranged parts of a single transaction intended from the outset to reach the ultimate result.” The interdependence test inquires whether, “on a reasonable interpretation of objective facts,” the steps were “so interdependent that the legal relations created by one transaction would have been fruitless without a completion of the series” of transactions. The interdependence test focuses on the relationships between the steps, rather than on their end result. The question is whether “any one step would have been undertaken except in contemplation of the other integrating acts.”

The court found that the transaction flunked all three tests under the facts of the case. By applying the step transaction doctrine, the court determined that the assets contributed to the LLC were an indirect gift to the recipients of the LLC interest gifts, and thus not entitled to a valuation discount based on LLC attributes.

In discussing similar cases where the step transaction was NOT applied, the court provided guidance for avoiding its application. The court noted in those other cases (Holman v. Comm'r, 130 T.C. 170 (2008); Gross v. Comm'r, 96 T.C.M. (CCH) 187, 2008 [TC Memo 2008-221] WL 4388277 (2008)) the assets contributed to the entity had the potential to materially fluctuate in value prior to the subsequent gifting of the interests in the entity. Also, in those other cases, the donor/contributor had made an affirmative and clear decision to delay the gifting of the interests until some time after the contribution of assets to the entity (even though the delay was only a few days). Practitioners seeking to avoid the application of the step transaction doctrine should be mindful of these types of facts.

Linton v. U.S., 104 AFTR 2d 2009-5176, 07/01/2009

1 comment:

S. Garrett Patricio said...

see Heckerman v. U.S., similar reasoning, same district court, different judge, 7/27/2009, recognizes "independent purpose and effect" to tax transactions beyond avoidance.