Ron Soluri Jr., CPA
Court Previously Held that the Exclusion Didn’t Apply
Author: Ron Soluri Jr.
Reversing its own recent trend, the U.S. Tax Court in Estate of Wimmer v. Commissioner held that gifts of interests in a family limited partnership (FLP) qualified for the federal annual gift tax exclusion. In three previous cases, the same court held that the exclusion didn’t apply to gifts of limited partnership interests.
Keeping it in the family
A husband and wife formed an FLP in 1996 and funded it entirely with publicly traded and dividend-paying stock. The FLP was intended in part to restrict nonfamily rights to acquire family assets. The couple made gifts of limited partnership interests in the FLP to various family members.
In 1996, the FLP received dividends from the stock and continued to receive them quarterly. It made distributions to the limited partners from 1996 through 1998 for payment of federal income tax. Beginning in 1999, the FLP continuously distributed all dividends — net of partnership expenses — to the partners when they were received, in proportion to partnership interests. In addition, limited partners had access to capital account withdrawals and used such withdrawals for, among other things, paying portions of their residential mortgages.
After the husband died and his estate filed an estate tax return, the IRS returned a tax deficiency of $263,711. The estate asked the Tax Court to find that the gifts of limited partnership interests qualified for the annual gift tax exclusion.
Siding with the estate
The annual gift tax exclusion is available only for “present interest gifts,” as opposed to gifts of future interests in property. As the court explained, a gift in the form of a transfer of an equity interest in a business or property, such as limited partnership interests, isn’t necessarily a present interest gift.
A present interest gift must confer on the recipient a substantial present economic benefit by reason of use, possession or enjoyment of either the property itself or income from the property. In Wimmer, the court easily found that the donees didn’t receive the rights to immediately use, possess or enjoy the limited partnership interests themselves because of the significant transfer restrictions in the FLP’s partnership agreement.
But the court also found that the estate satisfied the three requirements for income from the limited partnership interests to qualify the gifts of the interests as present interest gifts:
- The partnership would generate income.
- Some portion of that income would flow steadily to the limited partners.
- That portion of income could readily be ascertained.
The court therefore concluded that the limited partners received a substantial present economic benefit.
Learning Wimmer’s lesson
Wimmer shows how an FLP can be administered in such a way that it can put restrictions — which often are used to create valuation discounts — on gifted limited partnership interests while still satisfying the requirements for the gifts to qualify for the annual gift tax exclusion. A qualified financial professional can help you draft an appropriate operating agreement.
If you have any questions about the gift tax exclusion or any other litigation support issue, give us a call at 716.847.2651, or you may contact us here.