Tax Free Gifting

Posted on May 13, 2010 by John Hugg

I’m frequently asked: “How much can I give away tax free?” In 2010 you can give up to $13,000 in cash or property to any one person completely gift tax free. If you are married, you and your spouse can double that tax free gift to $26,000 per recipient. So if you have two children and four grandchildren a married couple could give a total of $156,000 ($26,000 to each of the six individuals). You may also pay for a person’s educational expenses or medical bills in the same year in addition to the direct gifts of $13,000 per person. Therefore, you could pay your grandchild’s college tuition and give him or her $13,000 ($26,000 if you are married) in 2010 without incurring any gift tax. One word of caution regarding tuition and medical – you must pay the institution or provider directly. Do not write the check to the individual and have them pay the school or hospital.

For individuals with substantial estates this can be an effective strategy to help your family members while reducing the value of your estate. You can therefore minimize your estate tax burden and still enjoy helping out your family.

There are a couple of things to keep in mind with gifting programs. First is that you are not entitled to get any of that money back. If you ultimately need those gifted funds, the recipient, if he or she still has the money, is under no legal obligation to help you out. The moral: be sure your gifting will not impoverish you. Second, if you have reason to believe you may need to qualify for Medicaid in the future, the state will look at all gifts within the five year period of time prior to applying for Medicaid. If there are gifts during this five year period, you may be ineligible to receive Medicaid for a period of time.
 

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Gifting LLC interests: Be safe rather than sorry?

Posted on October 13, 2009 by John Hugg

Recently, a number of cases have come out addressing when a gift of an LLC interest is really a gift of an underlying asset owned by the LLC. Two of these cases were decided right here in Federal District Court in Washington: Heckerman v. U.S., U.S. Dist. Ct., W.D. Washington, Cause No. C08-0211-JCC (July 27, 2009) and Linton v. U.S., U.S. Dist. Ct. W.D. Washington, Cause No. C08-227Z (July 1, 2009).

To summarize the cases very briefly, families in each case formed an LLC and the senior generation contributed various assets to the respective LLCs. On the same day the LLC contributions were made, gifts of LLC interests were made to trusts for their respective children. Each family claimed a valuation discount of the LLC interests for gift tax purposes. The IRS applied the indirect gift and step transaction doctrines to attempt to eliminate the discounts. In effect, the IRS said the parents made a gift of an actual asset and not an LLC interest. Valuation discounts apply to the latter. The IRS was successful in both cases.

The primary basis for denying the valuation discounts was the indirect gift doctrine. Application of this doctrine can frustrate a valuation discount if there is insufficient evidence to conclude what occurred first, funding the LLC or making gifts. In each case, with funding and gifting occurring on the same day, the necessary evidence was absent. An additional basis was the step transaction doctrine where a series of separate ‘steps’ are seen in substance as integrated, interdependent, and focused toward a particular result. There are three different tests used to determine if the step transaction doctrine applies in a given transaction: the “binding commitment test” where there is a binding commitment to undertake several different acts that, when viewed as a whole, are really one transaction; the “end result test” where one gleans an overriding transaction based on achieving an end result, such as tax savings; and the “interdependence test” where one act is ultimately fruitless without additional acts.

Can these problems be addressed with proper planning and drafting? Ultimately, the answer is somewhat unclear. What seems obvious is to set up an LLC or partnership first, then subsequently fund it with the assets desired. Other case law also indicates that when contributing property to the LLC the value of the asset should be attributable to the contributor’s capital account only. At a later point in time, seemingly the more elapsed time the better, a person would make gifts of the LLC interests. Presumably, if you are gifting to a trust, as is often the case, setting up the trust subsequent to the creation and funding of the LLC would seem prudent. Conducting affairs in this manner should automatically avoid the indirect gift doctrine and, assuming proper drafting, the “binding commitment test.” It should also go a long way to avoiding the “interdependence test,” however, given that the “end result test” can be apparently be satisfied by evidence of the “subjective intent” of the parties, it is unclear how one would plan to avoid this part of the step transaction doctrine. Stay tuned for further developments.
 

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