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July 15, 2012 The Tax Lawyer

Don’t Look a Gift Tax Exclusion in the Mouth: How Striving for Present Control Resulted in a “Future Interest” in Fisher v. United States

Vol. 65, No. 2 - Winter 2012

Laura Stake


    Since the enactment of the estate and gift taxes (transfer taxes) in the early twentieth century, estate planners and the government 1 have engaged in an ongoing game of tug of war, a struggle to expand or narrow the scope of permissible tax-free transfers from one generation to the next. When faced with a plan designed to minimize or eliminate a taxpayer’s transfer tax liability, the government’s response is usually to limit or deny the attempt. This back and forth engenders ever-increasing creativity in estate planning, and one popular tool in estate planning today is the use of limited liability companies (LLCs) to pass highly valued assets to family members at a discount while preserving some control over the assets in the transferor.

    One provision under which LLCs have proven to be useful in estate planning is section 2503(b), the gift tax annual exclusion. 3 Section 2503(b) excludes from a single taxpayer’s gift tax liability up to $13,000 of value per donee per year. However, the exclusion does not apply to “gifts of future interests in property.” Therefore, a gift of a future interest does not qualify for the annual exclusion and must be included in the total of gifts made subject to the gift tax. Though courts have developed a “substantial present economic benefit” standard for determining whether an interest transferred is considered a present or future interest, there is still much uncertainty about how to apply this standard in the context of new types of interests used in estate planning, particularly in the context of interests in LLCs.

    An illustration of this uncertainty is found in the Southern District of Indiana’s decision in Fisher v. United States and its Seventh Circuit predecessor, Hackl v. Commissioner . Prior to the decision in Hackl , most planners believed, and the Service had implied, that outright gifts of interests in LLCs would qualify for the annual exclusion, given the present possessory nature of the interests. The Hackl decision marked an interpretive shift in defining future interests within the meaning of section 2503(b), and staked out an extreme position in denying the exclusion for gifts of interests in certain LLCs

    The Service has signaled in subsequent cases that it may be willing to push the limits of the meaning of “future interests” as applied to LLC and partnership interests even further; more significantly, some courts are affirming the Service’s more taxpayer-restrictive positions. The Fisher decision is particularly troublesome because the court struck down one of the options that practitioners had proposed as a way to achieve annual exclusion treatment for gifts of partnership interests despite the Hackl ruling.

    This Note provides a detailed analysis of why the gifts of LLC units in Fisher were found to be gifts of a future interest within the meaning of section 2503(b), arguing that the interests transferred were ultimately not “substantial” enough to pass the “substantial present economic benefit” test. Further, this Note suggests that cases such as Fisher should serve as a warning that the government will closely scrutinize gifted LLC interests in estate planning. Part II provides the relevant background of the gift tax and the annual exclusion as applied to gifts of partnership interests. Part III provides an overview of the facts and the court’s holding in Fisher . Part IV analyzes the “substantial present economic benefit” test used in annual exclusion cases, and arrives at a potential rationale for finding the interests in Fisher to be future interests within the meaning of section 2503(b). Finally, Part V offers a brief conclusion.

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