Under the "check the box" Treasury Regulations, an individual owning an interest in a single member LLC will be treated by default as owning the assets of the entity directly (absent an election to have the LLC taxed as a corporation). The Regulations provide that such disregarded entity treatment will be for all Federal tax purposes.
The issue then arises whether such an owner will value interests in the LLC that are gifted as if the owner owned and gifted the underlying assets directly, or whether usual entity interest valuation principles can be applied based on the property law attributes of the ownership interest in the LLC. If the latter treatment is correct, the taxpayer can value the transferred interests with due regard for discounts for lack of marketability or lack of control - if the former treatment is applied, such discounts are likely unavailable.
This was the issue raised in a recent Tax Court case. In the case, the owner of the LLC transferred various percentage interests in the LLC by gift, and also sold some of those interests. The taxpayer sought to apply lack of marketability and lack of control discounts, for gift tax valuation purposes and the IRS argued that the above disregarded entity/"check the box" rules did not allow for such discounts.
In an opinion favorable to taxpayers (and notwithstanding a lengthy dissenting opinion), the Tax Court sided with the taxpayer and allowed the application of discounts. The Court applied gift tax law which provides that in valuing a gift, State law principles are applied to determine the characteristics of the transferred property. The federal "check the box" rules are not State law rules, and thus should not enter into determining the character of transferred property.
Under the applicable State law (New York), the taxpayer did not have a property interest in the underlying assets of LLC, since under New York law the LLC is recognized as an entity separate and apart from its members. Therefore, there was no State law legal interest or right in the underlying LLC assets that could be gifted - instead, the gift was of the ownership interest in the LLC, applying valuation principles relating to interests in entities.
Notably, the gifts involved in the case were of multiple smaller pieces of the LLC, and not one gift of the taxpayer's entire interest or a gift of a majority interest in the LLC. Presumably, if the gift had been of the taxpayer's entire interest or a majority interest, under entity valuation principles, it is likely that little or no discount would have been available.
Suzanne Pierre, 133 TC No. 2 (2009)
The issue then arises whether such an owner will value interests in the LLC that are gifted as if the owner owned and gifted the underlying assets directly, or whether usual entity interest valuation principles can be applied based on the property law attributes of the ownership interest in the LLC. If the latter treatment is correct, the taxpayer can value the transferred interests with due regard for discounts for lack of marketability or lack of control - if the former treatment is applied, such discounts are likely unavailable.
This was the issue raised in a recent Tax Court case. In the case, the owner of the LLC transferred various percentage interests in the LLC by gift, and also sold some of those interests. The taxpayer sought to apply lack of marketability and lack of control discounts, for gift tax valuation purposes and the IRS argued that the above disregarded entity/"check the box" rules did not allow for such discounts.
In an opinion favorable to taxpayers (and notwithstanding a lengthy dissenting opinion), the Tax Court sided with the taxpayer and allowed the application of discounts. The Court applied gift tax law which provides that in valuing a gift, State law principles are applied to determine the characteristics of the transferred property. The federal "check the box" rules are not State law rules, and thus should not enter into determining the character of transferred property.
Under the applicable State law (New York), the taxpayer did not have a property interest in the underlying assets of LLC, since under New York law the LLC is recognized as an entity separate and apart from its members. Therefore, there was no State law legal interest or right in the underlying LLC assets that could be gifted - instead, the gift was of the ownership interest in the LLC, applying valuation principles relating to interests in entities.
Notably, the gifts involved in the case were of multiple smaller pieces of the LLC, and not one gift of the taxpayer's entire interest or a gift of a majority interest in the LLC. Presumably, if the gift had been of the taxpayer's entire interest or a majority interest, under entity valuation principles, it is likely that little or no discount would have been available.
Suzanne Pierre, 133 TC No. 2 (2009)
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