Originally published on Passive Activities and Other Oxymorons on March 7th, 2011.
LINTON v. U.S., Cite as 107 AFTR 2d 2011-565, 01/21/2011
One of my earliest blog posts, mentioned the Lintons. I was toting up the score on family limited partnerships for 2009 declaring the year to be a tie with two wins for the IRS and two for the taxpayers. So early in the blogs existence I hadn't thought through all the implications of the scoring system. So I will leave it to the readers to determine whether we need to reopen the score book for 2009. The Lintons have appealed and appear to have won. Perhaps it would be more accurate to say they have gotten the game into overtime. In the first decision, the IRS won on "summary judgement". The appeals court is sending the case back for reconsideration.
You may have seen the cartoon on which the bumper sticker is based. Ferocious barbarians are running around the village with torches while the chieftain reflects that it is better to pillage first. That would seem to be a universal principle, but there are exceptions.
As I mentioned in a previous post, there are some excellent business and family reasons for establishing family limited partnerships. The excitement though is about the discounts. You put the assets in the family limited partnerships. The resulting value of the partnership interests is less than a proportional amount of the underlying assets. You need to form the partnership and put the assets in it before you make any gifts. If you give away an undivided interest in the assets and the donees contribute those undivided interests, it doesn't work. You need to do the thing that reduces the value, then make the gift - Burn, then pillage.
The parties have assumed that in determining the character of the Lintons' gifts, the sequencing of two transactions is “critical,” Senda v. Comm'r, 433 F.3d 1044, 1046 [97 AFTR 2d 2006-419] (8th Cir. 2006), and we do so too, without deciding whether that is always so in cases of this ilk. The transactions at issue are: (1) the contribution of cash, securities, and real property to the limited liability company, and (2) the transfer of LLC interests to the Lintons' children's trusts. If done in that order (and with some lapse of time between the transactions), as the Lintons contend occurred here, the gifts would ordinarily be characterized as gifts of LLC interests, and the value of those LLC interests might be discountable for tax purposes. If, however, the contributions to the LLC occurred after the transfer of LLC interests to the children's trusts, the gifts would ordinarily be characterized as indirect gifts of the particular contributed assets and would not be discountable.
In the first go round the court had concluded that things were done in the wrong order. The Lintons, however, insisted that they had done their burning before they pillaged. The problem is that this stuff is all just paperwork. The way you tell what order things were done in is by the dates on the paper. Here were the relevant documents :
Quit Claim Deed: signed by William and conveying a parcel of his separate property real estate to WLFB. The parties agree the quit claim deed was effective on January 22.
Assignment of Assets: signed by William as assignor and by both William and Stacy as assignees on behalf of the LLC.
Letters: signed by William and authorizing the transfer of securities and cash to WLFB. The parties disagree as to when the transfers of securities and cash were effected.
At the same meeting with attorney Hack, William, Stacy, and William's brother James Linton, signed, but left undated, several other documents:
Trust Agreements (four total—one for each child): signed by William and Stacy as grantors and by James as trustee; forming and apparently funding irrevocable trusts for the children.
Gift Documents (eight total—one each from William or Stacy to each trust): signed by William or Stacy as assignor and by James as trustee, gifting 11.25 percentage interests in WLFB to each respective trust.
Even though the burning documents were signed at the same meeting as the pillaging documents, the pillaging documents were not meant to be immediately effective. Then came the oops moment :
Two or three months later, attorney Hack assembled these key documents. For all undated documents, he filled in the missing date as January 22, 2003. In his deposition, Hack stated this insertion was erroneous, and that these documents should have been dated January 31, 2003. William agrees that January 31 was the correct date. This testimony is consistent with that of Caryl Thorp, an accountant with Moss Adams, LLP, who advised the Lintons on the ordering of the transactions.
Really what good is a lawyer's story with out a CPA to back him up ?
The case goes into a fairly interminable discussion of what constitutes a completed gift under the laws of the State of Washington. Here is the introduction to that discussion:
Under Washington law, “the elements of a completed gift are (1) an intention of the donor to give; (2) a subject matter capable of delivery; (3) a delivery; and (4) acceptance by the donee.” In re Marriage of Zier, 147 P.3d 624, 628 (Wash. Ct. App. 2006). The transfer of the LLC interests occurred when all four elements of a completed gift first existed simultaneously. We must determine when that was. We discuss each element individually, but we defer discussion of the first element, intention to give, until the end, as here it is both the decisive element and the most difficult to determine.
You probably don't want more of that, trust me.
They also discussed an entertaining theory advanced by the Lintons. The argument is that if the gift of the LLC interests happened before the transfer of the property, then the Lintons should have gotten credit for the property fair market value in their capital accounts. Hence if the IRS is right instead of a 47% discount, there is no gift all. The Court wasn't buying it.
The Lintons' “failed-gift” theory is clever; unfortunately for them, it is too clever. The membership ledger of the LLC shows that the capital accounts of the children's trusts were, in fact, increased, as does the LLC's informational return that its accountants prepared and filed with the IRS in March 2004. The Lintons contend that if we conclude the government is right about the timing of the transactions, these documents were prepared on a mistaken assumption (i.e., that the LLC interests were transferred after the assets, and, therefore, by virtue of the IRC § 704 capital account rules, included a pro rata transfer of the assets from the donors' capital accounts to the donees') and should be ignored. On their theory, the informational return and the ledger would only reflect what everyone believed to be the state of the capital accounts, not the actual state of the capital accounts.
But tax law is concerned “with the realities of a situation and not with the formalities of title.”...... The membership ledger and the LLC's informational return together reflect the substantive reality of the situation: All parties involved regarded the trusts' capital accounts as having been enhanced. In other words, all concerned parties acted as if William and Stacy Linton had “so parted with dominion and control [over the assets] as to leave in [them] no power to change [their] disposition.”
In the end. This is not the end. We will be hearing more about this case.
Genuine issues of material fact exist as to the sequence of transactions by which the gifts were made. We remand this question for the district court to determine, following further proceedings, when the four elements of a gift under Washington state law were simultaneously present, and, in particular, to determine when the Lintons first objectively manifested their intent to make the gifts effective. We also reverse the district court's grant of summary judgment in favor of the government as to the application of the step transaction doctrine. Finally, we affirm the district court's order denying summary judgment to the Lintons, holding that they are not entitled to summary judgment on their failed-gift theory.
I think the moral to the story is that forming a family limited partnership, funding it and making a gift of the partnership interests is probably worth more than one trip to the lawyer's office. Let the village burn for a month and then go back and pillage it.