Pierre v. Comm'r of Internal Revenue, No. 753–07.

• Decision Date: 24 August 2009
• Docket Number: No. 753–07.
• Parties: Suzanne J. PIERRE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Tax Court

133 T.C. 24

133 T.C. No. 2

Suzanne J. PIERRE, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 753–07.

United States Tax Court.

Aug. 24, 2009.

P transferred cash and publicly traded securities to LLC, a New York limited liability company, in exchange for a 100–percent interest in LLC. P subsequently made four transfers of her interest in LLC to trusts established for the benefit of her son and granddaughter: P transferred as a gift a 9.5–percent interest in LLC to each trust and then sold a 40.5–percent interest in LLC to each trust in exchange for a promissory note. In valuing the transfers for Federal gift tax purposes, P applied substantial discounts for lack of marketability and control and therefore paid no gift tax on the transfers.

R argues, inter alia, that the transfers should be treated as transfers of the underlying assets of LLC because a single-member limited liability company is a disregarded entity under the “check-the-box” regulations of secs. 301.7701–1 through 301.7701–3, Proced. & Admin. Regs.

Held: For purpose of application of the Federal gift tax, the transfers are to be valued as transfers of interests in LLC, and LLC is not disregarded under the “check-the-box” regulations to treat the transfers as transfers of a proportionate share of assets owned by LLC.

Kathryn Keneally and Meryl G. Finkelstein, for petitioner.

Lydia A. Branche, for respondent.

WELLS, Judge: ¹

Respondent determined deficiencies of $1,130,216.11 and $24,969.19 in petitioner's Federal gift tax and generation-skipping transfer tax for 2000 and 2001, respectively. The issue to be decided is whether certain transfers of interests in a single-member limited liability company (LLC) that is treated as a disregarded entity pursuant to sections 301.7701–1 through 301.7701–3, Proced. & Admin. Regs.,² known colloquially and hereinafter referred to as the check-the-box regulations, are valued as transfers of proportionate shares of the underlying assets owned by the LLC or are instead valued as transfers of interests in the LLC, and, therefore, subject to valuation discounts for lack of marketability and control.³

FINDINGS OF FACT

Some of the facts and certain exhibits have been stipulated by the parties. The facts stipulated by the parties are incorporated in this Opinion and are so found. Petitioner resided in New York at the time she filed the petition.

Petitioner received a $10 million cash gift from a wealthy friend in 2000. Petitioner wanted to provide for her son Jacques Despretz (Mr. Despretz) and her granddaughter Kati Despretz (Ms. Despretz) but was concerned about keeping her family's wealth intact. Richard Mesirow (Mr. Mesirow) helped petitioner develop a plan to achieve her goals.

On July 13, 2000, petitioner organized the single-member Pierre Family, LLC (Pierre LLC). Petitioner respected the formalities of formation in the State of New York, and Pierre LLC was validly formed under New York law. Petitioner did not elect to treat Pierre LLC as a corporation for Federal tax purposes by filing a Form 8832, Entity Classification Election, and therefore filed no corporate return for Pierre LLC.

On July 24, 2000, petitioner created the Jacques Despretz 2000 Trust and the Kati Despretz 2000 Trust (sometimes collectively referred to as the trusts).

On September 15, 2000, petitioner transferred $4.25 million in cash and marketable securities to Pierre LLC.

On September 27, 2000, 12 days after funding Pierre LLC, petitioner transferred her entire interest in Pierre LLC to the trusts. She first gave a 9.5–percent membership interest in Pierre LLC to each of the trusts to use a portion of her then-available credit amount and her GST exemption. She then sold each of the trusts a 40.5–percent membership interest in exchange for a secured promissory note. The notes each had a face amount of $1,092,133. Petitioner set this amount using the appraisal by James F. Shuey of James F. Shuey & Associates that valued a 1–percent nonmanaging interest in Pierre LLC at $26,965. Mr. Shuey determined the value of a 1–percent interest by applying a 30–percent discount to the value of Pierre LLC's underlying assets. However, petitioner admits that because of an error in valuing the underlying assets, a discount of 36.55 percent was used in valuing the LLC interest for gift tax purposes.

Petitioner filed a Form 709, United States Gift (and Generation–Skipping Transfer) Tax Return, for 2000 and reported the gift to each trust of a 9.5–percent Pierre LLC interest. She reported the value of the taxable gift to each trust as $256,168 (determined by multiplying a 9.5–percent interest times the $26,965 appraised value of a 1–percent nonmanaging interest in Pierre LLC).

Respondent examined petitioner's gift tax return and issued a deficiency notice for 2000 and 2001. Respondent determined that petitioner's gift transfers of the 9.5–percent Pierre LLC interests to the trusts are properly treated as gifts of proportionate shares of Pierre LLC assets valued at $403,750 each, not as transfers of interests in Pierre LLC. Respondent further determined that petitioner made gifts to the trusts of the 40.5–percent interests in Pierre LLC to the extent that the value of 40.5 percent of the underlying assets of Pierre LLC exceeded the value of the promissory notes from the trusts. Respondent valued each of these transfers at $629,117 after taking into account the value of the promissory notes.

OPINION

I. The Parties' Contentions

The parties do not dispute that Pierre LLC was a validly formed LLC pursuant to New York State law, which recognized Pierre LLC as an entity separate from petitioner under New York State law.⁴ They also agree that, at the time of the transfers, Pierre LLC is to be disregarded as an entity separate from its owner “for federal tax purposes” under the check-the-box regulations. The parties disagree, however, about whether the check-the-box regulations require that Pierre LLC be disregarded for Federal gift tax valuation purposes.

Respondent argues that, because Pierre LLC is a single-member LLC that is treated as a disregarded entity under the check-the-box regulations, petitioner's transfers of interests in Pierre LLC should be “treated” as transfers of cash and marketable securities, i.e., proportionate shares of Pierre LLC's assets, rather than as transfers of interests in Pierre LLC, for purposes of valuing the transfers to determine Federal gift tax liability. Accordingly, respondent contends that petitioner made gifts equal to the total value of the assets of Pierre LLC less the value of the promissory notes she received from the trusts.⁵

Petitioner argues that, for Federal gift tax valuation purposes, State law, not Federal tax law, determines the nature of a taxpayer's interest in property transferred and the legal rights inherent in that property interest. Accordingly, petitioner contends that we must look to State law to determine what property interest was transferred and then value the property interest actually transferred to apply the Federal gift tax provisions to that value to ascertain gift tax liability. Petitioner argues that, under New York State law, a membership interest in an LLC is personal property, and a member has no interest in specific property of the LLC. N.Y. Ltd. Liab. Co. Law sec. 601 (McKinney 2007). Accordingly, petitioner argues that she properly valued the transferred interests in Pierre LLC for purposes of valuing her transfers to the trusts and that she properly applied lack of control and lack of marketability discounts in valuing ⁶ the transferred LLC interests.

Petitioner also contends that respondent bears the burden of proof on all fact issues because she has met the requirements of section 7491.⁷ As the only issue decided in this Opinion is decided as a matter of law, we need not decide in this Opinion which party bears the burden of proof.⁸

II. The Historical Gift Tax Valuation Regime

We begin with a brief summary of the longstanding statutes, regulations, and caselaw that constitute the Federal gift tax valuation regime. Section 2501(a) imposes a tax on the transfer of property by gift. The amount of a gift of property is the value of the property at the date of the gift. Sec. 2512(a). It is the value of the property passing from the donor that determines the amount of the gift. Sec. 25.2511–2(a), Gift Tax Regs. “The value of the property is the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of the relevant facts.” Sec. 25.2512–1, Gift Tax Regs. Where property is transferred for less than adequate and full consideration in money or money's worth, the amount of the gift is the amount by which the value of the property transferred exceeds the value of the consideration received. Sec. 2512(b).

In addition to the statutes and regulations, there is significant Supreme Court precedent interpreting them and guiding the implementation of the Federal gift and estate tax.⁹ The Supreme Court, in Bromley v. McCaughn, 280 U.S. 124, 50 S.Ct. 46, 74 L.Ed. 226 (1929), held that the imposition of a gift tax is within the constitutional authority of Congress. The holding in Bromley turned on a finding that the gift tax is an excise tax rather than a direct tax. As the Supreme Court stated in Bromley v. McCaughn, supra at 135–136:

The general power to “lay and collect taxes, duties, imposts, and excises” conferred by Article I, § 8 of the Constitution, and required by that section to be uniform throughout the United States, is limited by § 2 of the same article, which requires “direct” taxes to be apportioned, and section 9, which provides that “no capitation or other direct tax shall be laid unless in proportion to the census” directed by the Constitution to be taken. * * *

* * * a tax imposed upon a particular use of property or the exercise...