Code Section 2503(b) allows taxpayers to make annual gifts to recipients of $13,000 per year (adjusted for inflation) without paying gift tax or using up any of their unified credit. To use Section 2503(b), the recipient of the gift must have a “present interest” in the property received and not a “future interest.” In Hackl v. Commissioner, 118 T.C. 279, 294 (2002), affd. 335 F.3d 664 [92 AFTR 2d 2003-5254] (7th Cir. 2003), the Tax Court previously held that there were so many restrictions on a transferred interest in an LLC that the recipient had no present benefit in the interest and thus transfers of the LLC interests could not qualify as annual exclusion gifts under Section 2503(b).
The Tax Court has now extended its reasoning to transfers of limited partnership interests, finding that transferred interests did not qualify as annual exclusion gifts. The case is notable for two reasons. First, for its extension of Hackl to limited partnership interests. Second, the case provided an exhaustive list of the economic restrictions that led the court to its conclusion. Presumably, in situations that have facts opposite to one or more of those on the list, a different result may apply.
The economic restrictions on the limited partnership interests that the court found determinative were:
a. Under the partnership agreement the donees have no unilateral right to withdraw their capital accounts;
b. The partnership agreement expressly prohibits partners from selling, assigning, or transferring their partnership interests to third parties or from otherwise encumbering or disposing of their partnership interests without the written consent of all partners;
c. Donees of interests are not full limited partners, but only receive an assignee interest (although the court did say that even if donees could become full substituted limited partners, this would not have changed their conclusion, so this factor alone is not determinative);
d. The partnership’s income does not flow steadily to the partners, with some years when no distributions of income were made;
e. Partnership profits are distributable only in the discretion of the general partner; and
f. Distributions of profits to assist partners in paying their taxes was only discretionary.
Since the foregoing factors are usually needed to suppress value for purposes of transfer taxes that are expected at death or for larger lifetime gifts, planners will often have to trade the loss of annual exclusion gifts for LLC or limited partnership interests for the greater savings on the anticipated larger lifetime or testamentary transfers. Nonetheless, some suggested planning nonetheless may still allow the best of both worlds. Such planning may involve the use of put rights, temporary rights to withdraw capital, and rights of first refusal on transfers in lieu of outright prohibitions.
Walter M. Price, et ux., TC Memo 2010-2