Hackl v. Comm'r
118 T.C. No. 14, 118 T.C. 279, 2002 U.S. Tax Ct. LEXIS 16 (2002)
Premium Feature
Subscribe to Lexplug to listen to the Case Podcast.
Rule of Law:
A gift of an equity interest in a business entity is a gift of a future interest, not a present interest, if the entity's operating agreement imposes substantial restrictions that prevent the donee from having an immediate and unrestricted right to the use, possession, or enjoyment of the property or the income from it. To be a present interest, the gift must confer a substantial present economic benefit upon the donee.
Facts:
- A.J. Hackl, a retired businessman, decided to invest in tree farming for long-term growth and to create a business for his family.
- In 1995, A.J. Hackl purchased two large tree farms with little to no merchantable timber, intending the business to be a long-term investment that would operate at a loss for many years.
- To hold these assets, A.J. Hackl formed Treeco, LLC, an Indiana limited liability company.
- A.J. Hackl and his wife, Christine M. Hackl, executed an operating agreement for Treeco which designated A.J. Hackl as the manager for life with exclusive authority over the company's business.
- The operating agreement stated that distributions of cash were at the sole discretion of the manager and that members could not withdraw their capital contributions without the manager's approval.
- The agreement also prohibited any member from transferring or selling their units without the prior written consent of the manager, which could be withheld in the manager's sole discretion.
- In March 1996, the Hackls gifted voting and nonvoting units of Treeco to their eight children, their children's spouses, and an irrevocable trust for their 25 minor grandchildren.
- From its formation through the years at issue, Treeco operated at a loss as anticipated and made no distributions to any of its members.
Procedural Posture:
- Christine and A.J. Hackl filed 1996 Federal gift tax returns, each claiming annual exclusions under § 2503(b) for gifts of Treeco, LLC units made to family members.
- The respondent, the Commissioner of Internal Revenue, issued statutory notices of deficiency determining that the gifts were of future interests and disallowing the claimed annual exclusions.
- The Hackls each filed a petition in the U.S. Tax Court seeking a redetermination of the deficiencies.
- The Tax Court consolidated the two cases for trial, briefing, and opinion.
- The parties submitted the case fully stipulated, with the sole issue for the court's decision being whether the gifts qualified for the annual exclusion.
Premium Content
Subscribe to Lexplug to view the complete brief
You're viewing a preview with Rule of Law, Facts, and Procedural Posture
Issue:
Do gifts of limited liability company (LLC) units, which are subject to an operating agreement that restricts the donees' ability to transfer the units or compel distributions, qualify for the annual gift tax exclusion under § 2503(b) as a gift of a present interest?
Opinions:
Majority - Nims, Judge
No, gifts of LLC units do not qualify for the annual gift tax exclusion as a present interest where the operating agreement severely restricts the donees' ability to transfer the units or compel distributions, thereby failing to confer a substantial present economic benefit. For a gift to be a 'present interest,' it is not enough that the donee receives vested title; the donee must have the immediate right to 'use, possess or enjoy the property,' which connotes a 'substantial present economic benefit.' The court rejected the Hackls' argument that an outright transfer of legal title automatically qualifies. Instead, the court analyzed whether the donees received a present economic benefit from either the LLC units themselves or the income from the units. Regarding the units themselves, the operating agreement foreclosed any present benefit because donees could not unilaterally sell their units to a third party, demand redemption from the company, or otherwise access the value of their capital accounts. Regarding income, the court found no present benefit because the company was not projected to be profitable for years, and even if it were, distributions were entirely at the manager's discretion, meaning there was no ascertainable portion of income that would flow to the donees. Therefore, any economic benefit was postponed, making the gifts ones of a future interest not eligible for the § 2503(b) exclusion.
Analysis:
This decision solidifies the principle that substance over form governs the determination of a 'present interest' for gift tax purposes. The court extended the 'substantial present economic benefit' test, often applied to gifts in trust, to outright gifts of interests in closely-held entities like LLCs. This ruling significantly impacts estate planning, cautioning that standard, commercially reasonable restrictions in an LLC operating agreement or partnership agreement can inadvertently convert gifts into non-excludable future interests. Planners must now carefully draft entity agreements to ensure that gifted interests provide donees with a sufficient, immediate, and tangible economic benefit, such as a right to sell or a defined right to income, to qualify for the annual exclusion.
