Pierre v. Comm'r
133 T.C. 24, 133 T.C. No. 2, 2009 U.S. Tax Ct. LEXIS 21 (2009)
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Rule of Law:
For Federal gift tax valuation purposes, State law determines the nature of the property interest transferred, and the 'check-the-box' regulations (which allow certain entities to be 'disregarded for federal tax purposes') do not override State law to treat transfers of interests in a single-member limited liability company (LLC) as transfers of proportionate shares of its underlying assets.
Facts:
- In 2000, Petitioner received a $10 million cash gift from a wealthy friend.
- On July 13, 2000, Petitioner organized the single-member Pierre Family, LLC (Pierre LLC) under New York law, and did not elect to treat it as a corporation for Federal tax purposes.
- On July 24, 2000, Petitioner created the Jacques Despretz 2000 Trust and the Kati Despretz 2000 Trust.
- On September 15, 2000, Petitioner transferred $4.25 million in cash and marketable securities to Pierre LLC.
- On September 27, 2000, Petitioner transferred her entire interest in Pierre LLC to the trusts, giving a 9.5% membership interest to each trust and selling a 40.5% interest to each trust in exchange for secured promissory notes.
- Petitioner used an appraisal that applied a 30% (or 36.55% due to error) discount to the value of Pierre LLC’s underlying assets to value the LLC interests for gift tax purposes.
- Petitioner reported the gift tax liability based on the discounted value of the LLC interests.
Procedural Posture:
- Petitioner filed a Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, for 2000 and 2001, reporting gift transfers of Pierre LLC interests at a discounted value.
- Respondent (IRS) examined Petitioner's gift tax return and issued a deficiency notice, determining the transfers should be valued as proportionate shares of Pierre LLC's underlying assets without discounts.
- Petitioner filed a petition with the United States Tax Court challenging the respondent's determination of gift tax deficiencies.
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Issue:
Does the 'check-the-box' regulation, which treats a single-member LLC as a disregarded entity for federal tax purposes, require that transfers of interests in such an LLC be valued for Federal gift tax purposes as transfers of proportionate shares of the underlying assets, rather than as transfers of interests in the LLC itself?
Opinions:
Majority - Judge Wells
No, the 'check-the-box' regulations do not require transfers of interests in a single-member LLC to be valued for Federal gift tax purposes as transfers of the underlying assets. The Court held that a fundamental premise of transfer taxation is that State law creates property rights and interests, and Federal tax law then defines the tax treatment of those property rights. Under New York law, Pierre LLC was a valid entity separate from Petitioner, and Petitioner, as a member, did not have a property interest in its underlying assets. The check-the-box regulations classify entities for Federal tax purposes (e.g., as pass-through or separately taxed) primarily to simplify administration related to income and employment tax consequences, but they do not redefine the nature of property interests created under State law for gift tax valuation. To interpret these regulations as overriding State law on property rights for gift tax valuation would be 'manifestly incompatible' with Section 7701 and the longstanding Federal gift tax valuation regime, which relies on the 'willing buyer, willing seller' standard. The Court noted that Congress has enacted specific anti-abuse provisions in Chapter 14 (Sections 2701-2704) where it intended to disregard valid State law restrictions for valuation, indicating that such changes are for Congress to make, not for regulations to infer.
Concurring - Judge Cohen
No, the 'check-the-box' regulations do not require transfers of interests in a single-member LLC to be valued for Federal gift tax purposes as transfers of the underlying assets. Judge Cohen agreed with the majority, distinguishing prior employment tax cases (such as McNamee) as dealing with entity classification and tax liability, not the valuation of transferred interests. When property is transferred, its fair market value is determined by the 'willing buyer, willing seller' standard, and a hypothetical buyer would not disregard an LLC validly created and recognized under State law. She emphasized that the 'check-the-box' regulations, intended as a targeted solution for entity classification, should not be 'distorted to achieve a comprehensive overhaul of a well-established body of law' like gift tax valuation. The phrases 'federal tax purposes' and 'disregarded' in the regulations are ambiguous and must be interpreted to avoid conflict with statutory principles. Respondent's position in this case is a mere 'litigating position' and not a consistent administrative interpretation warranting Chevron deference, especially as it is 'manifestly incompatible' with established valuation principles.
Dissenting - Judge Halpern
Yes, the 'check-the-box' regulations do require transfers of interests in a single-member LLC to be valued for Federal gift tax purposes as transfers of the underlying assets. Judge Halpern argued that the 'activities instruction' in Section 301.7701-2(a) of the regulations states that a single-member disregarded entity's activities are treated like a sole proprietorship. This means the entity has no legal identity apart from its owner for federal tax purposes, encompassing the Federal gift tax. Therefore, a gift of an interest in the LLC should be seen as a gift of an interest in the LLC’s cash and marketable securities. He contended that the Commissioner’s consistent interpretation in other contexts (e.g., income tax consequences of selling LLC interests, per Rev. Rul. 99-5 and private letter rulings) supports disregarding the entity's 'wrapper' for valuation, as gifts and sales are fundamentally similar. He asserted that Section 7701(a) is ambiguous regarding single-member LLCs, and thus the check-the-box regulations are a valid exercise of administrative authority under Chevron deference, capable of overriding prior judicial precedent on State law property concepts for Federal gift tax purposes, just as they did for employment tax liability in McNamee.
Dissenting - Judge Kroupa
Yes, the 'check-the-box' regulations do require transfers of interests in a single-member LLC to be valued for Federal gift tax purposes as transfers of the underlying assets. Judge Kroupa strongly dissented, arguing the majority ignored the plain language of the check-the-box regulations, which explicitly state an LLC should be 'disregarded as an entity separate from its owner for federal tax purposes.' She contended that 'federal tax purposes' is broadly inclusive of all federal taxes, including gift tax, and is not limited to income tax, as the drafters could have specified. She pointed to consistent administrative guidance (e.g., Rev. Rul. 99-5 and private letter rulings for like-kind exchanges) where the owner of a single-member LLC is treated as owning its underlying assets. She emphasized that federal law determines the meaning of 'property' for tax purposes (United States v. Craft), not State law. Furthermore, she argued the majority implicitly invalidated the regulations without proper Chevron analysis, despite precedent (McNamee, Littriello) upholding their validity even when overriding State law protections (like limited liability) for other federal tax purposes. She concluded that the taxpayer's choice to have the LLC disregarded for federal tax purposes should lead to the consequence of valuing the underlying assets, consistent with the broad scope of gift tax and 'substance over form' principles.
Analysis:
This case significantly reinforces the traditional role of state law in defining property interests for federal transfer tax purposes, while limiting the scope of the 'check-the-box' regulations primarily to entity classification for income and employment tax. It highlights the judiciary's reluctance to infer a 'comprehensive overhaul' of established tax principles through administrative regulations without explicit congressional intent. The decision provides clarity for taxpayers using single-member LLCs in estate planning, affirming that discounts for lack of marketability and control may still apply to LLC interests even if the entity is otherwise disregarded for federal tax purposes. However, it also underscores the ongoing tension between administrative simplification rules and established substantive tax law, potentially inviting future legislative action or further litigation on the bounds of regulatory authority.
