june 2010: having lost the war on family lcc, irs loses the battle on discounts

8/7/2019 June 2010: Having Lost The War On Family LCC, IRS Loses The Battle On Discounts

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JUNE 2010

Case Update - June 2010 provided by BV Resources | Sherrye Henry, editor [email protected]___________________________________________________________________________________________________________________

Pierre v. Commissioner, 2010 WL 1945779 (U.S. Tax Ct.)(May 13, 2010)

ASA members may remember the Tax Court’s frst opinion in these proceedings. In Pierre v. Comm’r, 2009 WL 2591652 (Aug. 24,2009)(Pierre I), the taxpayer ormed a single-member amily limited liability company (LLC). She then created two trusts or her sonand granddaughter. Nearly two months later, she trans erred $4.25 million in marketable securities into the amily LLC. Twelve daysa ter that, the taxpayer trans erred her entire interest in the amily LLC to the trusts, giving 50% to each trust. Her advisors laterdetermined that she could gi t a certain amount tax- ree. Accordingly, the petitioner sold each trust a 40.5% membership in return

or two promissory notes o $1.09 million apiece, and gi ted them each a 9.5% interest. An appraiser arrived at the note amountsa ter valuing a 1% interest in the LLC at $26,965, including a 36.5% combined discount or lack o marketability and lack o control.

In assessing defciencies o over $1.13 million, the IRS argued that pursuant to applicable Treasury Regulations, the entity ormo a single-member LLC should be ignored or ederal gi t tax purposes. Accordingly, it treated the trans er o LLC interests to the

children’s trusts as trans ers o proportionate shares o the underlying LLC assets, to be assessed at ull, air market value. In asplit decision (9 to 6), the U.S. Tax Court sided with the taxpayer, despite a dissent that would have disregarded the amily LLC as aseparate entity when assessing ederal gi t tax liability.

The court postponed deciding the valuation issues, however, including the application and magnitude o the discounts. It also puto the question whether the “step transaction doctrine” would collapse the LLC and trust trans ers into a single transaction. In thiscurrent opinion (Pierre II), the court addresses both questions.

Tax avoidance was the primary purpose. The court frst examined the amily LLC’s operations and agreements. Forinstance, the LLC essentially ignored the promissory notes, having made su fcient distributions to the trusts to pay interest butreceiving no principal payments in eight years. Further, although the taxpayer was the designated manager o the LLC, neither shenor her grown son actively managed the LLC or attended its sporadic meetings. In 2000, at the time o the LLC’s ormation and

unding, an attorney/advisor prepared a single ledger to record the distribution o capital and to prepare the taxpayer’s original gi ttax returns. Notably, he credited each trust’s capital account with 50% o the value o the taxpayer’s original $4.25 million contribu-tion, and discarded the ledger a ter fling the tax returns.

At trial, the attorney testifed that he discarded the records because they characterized the trans ers inaccurately, ailing to includethe our subsequent gi t and sale transactions. The court was not persuaded. “We do not so easily ignore [his] contemporaneousdescription o the transaction,” the court said. Nor would it overlook the taxpayer’s “primarily tax-motivated reasons or structuringthe gi t trans ers as she did.” The our gi t and sale transactions were planned as a single transaction and took place at virtuallythe same time, with no independent, intervening non-tax event. The taxpayer intended not just to minimize her tax liability, the courtsaid, “but to eliminate it entirely.” Under these circumstances, including the LLC’s ailure to observe ormal operations ( ailure topay down the note, etc.), the court applied the step transaction doctrine to collapse the separate trans ers into a single deal.

Given this ruling, the court valued the LLC interests not by re erence to the trust’s ownership but by their value in the taxpayer’shands. The parties agreed that, under the air market value standard, a willing buyer/willing seller would pay less or the LLCinterests than or an outright purchase o the same block o reely traded marketable securities. To prove the applicable discounted

HAVING LOST THE WAR ON FAMILY LCC,IRS LOSES THE BATTLE ON DISCOUNTS



JUNE 2010

value, the taxpayer o ered the original discounted appraisal (10% or minority interest and 30% or lack o marketability (DLOM)or a combined 36.5% discount) as well as a second appraisal, prepared specifcally or trial. This second expert also concluded a

10% minority discount, but believed a 35% DLOM was appropriate resulting in a cumulative 41.5% discount.

Notably, the IRS chose not to present its own exper t valuation, relying instead on its original claims, in Pierre I, that the gi ts wereo the underlying assets o the LLC. Having lost that argument, in Pierre II, the IRS simply requested the court to reduce the tax-payer’s proposed discounts.

Taxpayer wins by default? Although the taxpayer’s trial exper t agreed with the original assessment o a 10% minoritydiscount, he conceded that this applied to LLC interests o 40.5% and 9.5%. I he’d reviewed the rights and restrictions applicableto a 50% interest in the LLC, he would have reduced the discount to 8%, he said. Given the court’s collapse o the gi t and saletransactions into trans ers o 50% apiece, it accepted and applied the 8% discount or lack o control.

Despite her trial exper t’s 35% DLOM, the taxpayer advocated or only 30%, as set orth in her original appraisal. Although the IRSargued that a 35% marketability discount was too high, it ailed to contest the 30% DLOM at trial. Further, the IRS o ered no evi-dence or expert testimony concerning the LLC interests. Based on the available evidence, presented by the taxpayer, the court heldthat a 30% marketability discount was appropriate and applied the same.

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june 2010: having lost the war on family lcc, irs loses the battle on discounts

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