Hackl v. Comm'r of Internal Revenue
| Decision Date | 27 March 2002 |
| Docket Number | Nos. 6921–00,6922–00.,s. 6921–00 |
| Parties | Christine M. HACKL, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentAlbert J. HACKL, Sr., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Taxpayers petitioned for redetermination of IRS denial of present interest treatment for gifts of interests in limited liability company (LLC). The Tax Court, Nims, J., held that gifts were not present interests which would entitle taxpayers to gift tax annual exclusion.
Decision for IRS. Barton T. Sprunger and Mark J. Richards, for petitioners.
Russell D. Pinkerton, for respondent.
In 1995 and 1996, Ps A and C made gifts to their children and grandchildren of membership units in Treeco, LLC, a limited liability company. Treeco had previously been organized by A to hold and operate tree farming properties. This timberland had been purchased by A to provide investment diversification in the form of long-term growth and future income. Treeco was governed by an Operating Agreement which set forth the rights and duties conferred on members and the manager and which designated A as manager. At the time of the gifts, it was correctly anticipated that Treeco and its successor entities would generate losses and make no distributions for a number of years.
Held: The gifts of Treeco units made by Ps fail to qualify for the annual gift tax exclusion provided in sec. 2503(b), I.R.C.
By separate statutory notices, respondent determined a deficiency in the 1996 Federal gift tax liability of petitioner Christine M. Hackl (Christine Hackl) in the amount of $309,866 and in the 1996 Federal gift tax liability of Albert J. Hackl, Sr. (A.J.Hackl), in the amount of $309,950. Petitioners each timely filed for redetermination by this Court, and, due to an identity of issues, the cases were consolidated for purposes of trial, briefing, and opinion. In accordance with stipulations of partial settlement filed by the parties, the sole matter remaining for decision is whether gifts made by petitioners of units in a limited liability company qualify for the annual exclusion provided by section 2503(b).
Unless otherwise indicated, all section references are to sections of the Internal Revenue Code in effect for the year at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
These cases were submitted fully stipulated pursuant to Rule 122, and the facts stipulated are so found (except as noted in footnote 1). The stipulations of the parties, with accompanying exhibits, are incorporated herein by this reference. At the time their respective petitions were filed, petitioners resided in Indianapolis, Indiana.
Petitioners are husband and wife and are the parents of eight children. As of the date of the gifts at issue, they were also the grandparents of 25 minor grandchildren.
A.J. Hackl was born on December 29, 1925, and Christine Hackl was born on June 16, 1927. Since obtaining a Bachelor of Mechanical Engineering degree from Georgia Institute of Technology in 1946, A.J. Hackl has pursued a successful career in business. He was employed by The Trane Company from 1946 to 1959, during which time he became a licensed professional engineer and worked in several management positions. He next accepted employment with Worthington Corporation, serving in management and executive capacities within the company's air conditioning division from 1959 to 1968. Then, from 1968 until his retirement in 1995, A.J. Hackl served as chief executive officer of Herff Jones, Inc. During that period, Herff Jones grew from a small, publicly held manufacturer of scholastic recognition and motivational awards, with $18 million in annual sales, to a national company with a broad line of products and annual sales of $265 million. At the time of his retirement in 1995, A.J. Hackl owned a significant amount of Herff Jones stock, which he sold to the company's employee stock ownership plan. He then remained as chairman of the board of directors until 1998.
In the mid–1990s, in anticipation of the sale of his Herff Jones stock, A.J. Hackl began to research ways to diversify his financial net worth into investments other than publicly traded U.S. marketable securities, of which he had already accumulated a substantial portfolio. He concluded that an investment in real estate would achieve his objective of diversification and, after consideration of a wide range of real estate ventures, decided that tree farming presented an attractive business opportunity which would both include the acquisition of significant parcels of real estate and also fulfill his interest of remaining personally active in business.
Since his other investments were generating a considerable amount of current income, A.J. Hackl's investment goal with respect to his tree farming business was long-term growth. He therefore chose to purchase land for use in the tree farming business with little or no existing merchantable timber because such land was significantly cheaper, and would provide a greater long-term return on investment, than land with a substantial quantity of merchantable timber.
In 1995, A.J. Hackl purchased two tree farms: (1) A 3,813.8 acre tract in Putnam County, Florida (Putnam County Farm) and (2) a 7,771 .88 acre tract in McIntosh County, Georgia (McIntosh County Farm). The Putnam County Farm was purchased on January 6, 1995, for $1,945,038, and contained merchantable timber valued at $140,451 as of the time of purchase. The McIntosh County Farm was purchased on June 23, 1995, and contained no merchantable timber as of that date.
A.J. Hackl determined that the tree farming operations should be conducted by a separate business entity (1) to shield his assets not related to the tree farming business from potential liability associated with that business, (2) to create a separate enterprise in which family members could participate, and (3) to facilitate the transfer of ownership interests in the tree farming business to his children, their spouses, and his grandchildren. Accordingly, A.J. Hackl executed Articles of Organization creating Treeco, LLC, and on October 6, 1995, such articles were filed with the Office of the Indiana Secretary of State. As a result, Treeco was duly and validly organized as a limited liability company (LLC) under the Indiana Business Flexibility Act. The LLC format was selected by A.J. Hackl to obtain liability protection for members, to provide protection of assets inside the LLC from members' creditors, to provide pass-through income tax treatment, and to provide for centralized management for the operation of the family tree farming business.
On December 7, 1995, A.J. Hackl contributed the Putnam and McIntosh County Farms to Treeco. Thereafter, on December 11, 1995, petitioners each recorded a capital contribution to Treeco of $500 in exchange for 50,000 voting and 450,000 nonvoting units in the LLC, thereby becoming the initial members of the entity and each holding 50–percent ownership. They also on that date, in their capacities as initial members, executed an Operating Agreement to govern the Treeco enterprise.
The Operating Agreement provided that “Management of the Company's business shall be exclusively vested in a Manager” and specified that such manager “shall perform the Manager's duties as the Manager in good faith, in a manner the Manager reasonably believes to be in the best interests of the Company, and with such care as an ordinarily prudent person in a like position would use under similar circumstances.” The document designated A.J. Hackl as the initial manager to serve for life, or until resignation, removal, or incapacity, and also conferred on him the authority to name a successor manager during his lifetime or by will.
As regards distributions, the Agreement stated that the manager “may direct that the Available Cash, if any, be distributed to the Members, pro rata in accordance with their respective Percentage Interests.” Available cash was defined as cash funds on hand after payment of or provision for all operating expenses, all outstanding and unpaid current obligations, and a working capital reserve. In addition, the Agreement provided that, prior to dissolution, “no Member shall have the right to withdraw the Member's Capital Contribution or to demand and receive property of the Company or any distribution in return for the Member's Capital Contribution, except as may be approved by the Manager.” Members also in the Agreement waived the right to have any company property partitioned.
Concerning changes in members and disposition of membership interests, the Operating Agreement set forth specific terms with respect both to withdrawal of members and transfer of membership interests. Members could not withdraw from Treeco without the prior consent of the manager. However, under the Agreement “A Member desiring to withdraw may offer his Units for sale to the Company, in the person of the Manager, who shall have exclusive authority on behalf of the Company to accept or reject the offer, and to negotiate terms.” Pertaining to transfer of interests, the document recited as follows:
No Member shall be entitled to transfer, assign, convey, sell, encumber or in any way alienate all or any part of the Member's Interest except with the prior written consent of the Manager, which consent may be given or withheld, conditioned or delayed as the Manager may determine in the Manager's sole discretion.
If a transfer was permitted in accordance with this provision, the transferee would have the right to be admitted as a substitute member. If a transfer was made in violation of the foregoing procedure, the transferee would be afforded no opportunity to participate in the business affairs of...
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