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Disclaimer and Warning - From Bob Parrish
CPA, P.C.
Executive Summary -
The tax laws, regulations, and IRS positions, and IRS audit techniques all agree and require all gifts of any property, tangible or intangible to be included. Moreover - those same authorities require all transactions, transfers, or other circumstances to be included whether the transaction is indirect or indirect.
The risks are that the IRS will tax you on the transfers, and/or tax your estate on the transfers.
An example -
A parent contributes money to a family limited partnership. The parent has just made an indirect gift to all other non-contributing partners. This is subject to the gift tax. Moreover at times circumstances will exist that the gift is considered what is known as a future gift and the transfer will be included in the parent's estate (and not considered a gift). This will thwart some of the main reasons for the transfer.
Cure -
Allow me to perform a routine checkup of your chosen entity and underlying transactions. A common treatment to cure the ailment is to adjust the partners' capital accounts as of any date a partner places any tangible or intangible property into the partnership.
Proof The IRS Requires
Prepare for Your Adviser
Qualified Expenses
INDIRECT TRANSFERS - What They Are (and thus how to avoid them)
The gift tax applies to a transfer by way of gift whether direct or indirect and
whether the property is real or personal, tangible or
intangible. Reg. Section 25.2511-1(a).
For example, a transfer of property by a taxpayer to a corporation generally
represents gifts by the taxpayer to the other individual shareholders of the
corporation to the extent of their proportionate interests in the corporation.
Reg. Section 25.2511-1(h)(1).
Referred to as the indirect gift analysis, this regulation has been applied
repeatedly by the IRS and the courts to foreclose taxpayers' attempts to reduce,
or eliminate altogether, the gift tax on transfers through the use of valuation
discounts and/or the annual gift tax exclusion.
Specifically, many taxpayers have sought to leverage their annual exclusion
allowance from the gift tax by transferring assets to several individuals with
the understanding that these individuals will, in turn, transfer the assets to
the taxpayer's intended donees. The courts have consistently held that an
individual cannot increase the number of available exclusions by using other
individuals as in effect intermediaries. {1} The
annual exclusion from the gift tax is discussed in Section 759.5(a).
The indirect gift analysis has also been successfully applied by the IRS to the
reciprocal gift context. Derived from the reciprocal trust doctrine set forth in
United States v. Estate of Grace, 395 U.S. 316 (1969), reciprocal gifts refers
to circumstances under which taxpayers agree to make similar gifts to one
another's intended donees, typically using their annual exclusion allowances, so
that each donee ultimately receives far more than the gift tax exclusion. For
example, brothers who agreed to give each other's children gifts utilizing their
annual exclusion amounts has been held to be nothing more than indirect
transfers of the full amount given to each child by his or her own parent. {2}
In one instance, the Eighth Circuit reached this result even though
the transfers were of stock in different companies. Estate of Schuler v.
Commissioner, Dkt: 01-2109 (8th Cir. Mar. 7, 2002). There, the court held that
transfers of stock in two separate corporations could be considered reciprocal
gifts because the economic value of the stock transferred by the brothers was
nearly the same.
Transfers made to entities, such as corporations and partnerships, are also
generally considered to be indirect gifts made to the owners of the entities. {3}
The IRS has been successful in reducing and, in some cases, eliminating the
amount of the valuation discount taxpayers have sought to apply to their
transfers for gift tax purposes. {4} In Shepherd v.
Commissioner, Dkt: 01-12250 (11th Cir. Feb. 28, 2002), the court held that
because the taxpayer first created a partnership in which his sons held
established shares and then transferred property to the partnership, whatever
interests the sons acquired in the property they obtained by virtue of their
status as partners in the partnership. Consequently, the court found that the
taxpayer's contribution of the property to the partnership was an indirect gift
to his sons and that the only appropriate valuation discounts were those that
reflected the nature of the transferred assets, i.e., shares of closely held
stock and land. In disallowing greater discounts, the court concluded that only
the characteristics of a gift and not a donee's method of receiving the gift
(e.g., through a partnership interest) were relevant to the determination of the
value of the gift for gift tax purposes. In TAM 200212006, the
IRS ruled that the taxpayer was not entitled to any valuation discount on a
transfer of municipal bonds to a partnership in which her children were
partners. In contrast to the Shepherd case, the IRS pointed out that this
taxpayer had transferred municipal bonds which were readily marketable
publicly-traded securities that could be easily divided among the donees and, as
such, were analogous to gifts of cash for which no valuation discount is
allowable under Reg. Section 25.2511-2(a).
Moreover, the IRS has also been successful in holding that transfers to entities
also do not qualify for the taxpayer's annual exclusion from the gift tax
because they are only gifts of future interests. As such, and until an
entity is liquidated, dissolved, or pays a dividend, the general view is that
the recipient has no present realizable interest; and therefore such gifts
constitute future interests and do not qualify for the annual gift tax
exclusion. For example, the forgiveness of debt to a corporation, which
constitutes a gift to the corporation, is an indirect gift to the corporate
shareholders and also does not qualify for the annual gift tax exclusion.
Stinson Estate v. United States, 214 F.3d 846 (7th Cir. 2000).
Law (commentary and citation)
Regs (commentary and citation)
(a) The gift tax applies to a transfer by way of gift whether
the transfer
is in trust or otherwise, whether the gift is direct or indirect, and
whether the property is real or personal, tangible or intangible. For
example, a taxable transfer may be effected by the creation of a trust,
the forgiving of a debt, the assignment of a judgment, the assignment of
the benefits of an insurance policy, or the transfer of cash, certificates
of deposit, or Federal, State or municipal bonds. Statutory provisions
which exempt bonds, notes, bills and certificates of indebtedness of the
Federal Government or its agencies and the interest thereon from taxation
are not applicable to the gift tax, since the gift tax is an excise tax on
the transfer, and is not a tax on the subject of the gift.
(1) A transfer of property by a corporation to B is a gift to B
from
the stockholders of the corporation. If B himself is a stockholder,
the transfer is a gift to him from the other stockholders but only to
the extent it exceeds B's own interest in such amount as a
shareholder. A transfer of property by B to a corporation generally
represents gifts by B to the other individual shareholders of the
corporation to the extent of their proportionate interests in the
corporation. However, there may be an exception to this rule, such as
a transfer made by an individual to a charitable, public, political
or similar organization which may constitute a gift to the
organization as a single entity, depending upon the facts and
circumstances in the particular case.
Cases (commentary and citation)
§§§ Law §§§
Comments
{1] Heyen v. United States, 945 F.2d 359 (10th
Cir. 1991) (where the
donor transferred shares of bank stock to 29 people and all but two of
the donees then transferred their stock to members of donor's family);
Estate of Bies v. Commissioner, T.C. Memo. 2000-338 (annual transfers of
closely held corporation stock to donor's daughters-in-law were indirect
gifts to the donor's sons and, thus, did not yield additional annual
exclusions).
{2} Estate of Schuler v. Commissioner, Dkt:
01-2109 (8th Cir. Mar. 7,
2002); Sather v. Commissioner, 251 F.3d 1168 (8th Cir. 2001).
{3} Shepherd v. Commissioner, Dkt: 01-12250
(11th Cir. Feb. 28,
2002), aff'g 115 T.C. 376 (2000) (transfer of land to partnership was
indirect gift to other partners); Heringer v. Commissioner, 235 F.2d 149
(9th Cir. 1956) (transfer of farm land to family corporation of which the
donors were 40% owners were gifts to the other shareholders in the amount
of 60% of the fair market value of the land); Georgia Ketteman Trust
v.Commissioner, 86 T.C. 91 (1986) (transfer of property to closely held
corporation in exchange for note of lesser value was gift to the other
shareholders); Estate of Bosca v. Commissioner, T.C. Memo. 1998-251
(father's transfer of voting common stock to a family corporation in
exchange for non-voting common stock was a gift to each of his
shareholder-sons of the difference between the value of the stock
transferred and the value of the stock received); Rev. Rul. 71-443,
1971-2 C.B. 337 (gift tax marital deduction allowed for a portion of the
property transferred to a corporation in which the donor's spouse was a
shareholder).
4. Shepherd v. Commissioner, Dkt: 01-12250 (11th Cir. Feb. 28,
2002), aff'g 115 T.C. 376 (2000). See also TAM 200212006 (taxpayer's
transfer of bonds to partnership in which her children were partners was
properly characterized as an indirect gift of the bonds to each of the
children, even if the taxpayer's contribution had been initially
allocated to her capital account and only then reallocated to the capital
accounts of her children); and FSA 200143004. (entity could be
disregarded as lacking economic substance and therefore, transfers were
nothing more than indirect gifts of proportionate shares in the entity's
underlying assets).
§§§ Cases §§§
The best strategy is to use the tool with prudence. Watch carefully all events regarding the capital and make new percentages where needed.
Simple analogy: If you were to invest in a public traded partnership an amount of $10,000 you would be credited with a percentage of its profits. If the partnership performed very good and you wanted to invest more money - for example another $10,000 you would expect to have your capital account percentage increase. You certainly would be disappointed if you invested an additional $10,000 but did not have a larger share of money.
I shall always strive to accomplish your goals, and to keep your planning in balance. You will find no other adviser or groups of advisers that has your potential and your security more in focus than I.
Call Me
Simply to Help —Helping You To
Keep More Of What You Earn, and Helping You To Protect What You Keep
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Help To Keep Your Life In Balance
Very truly yours,
by
Bob Parrish CPA Engagement Manager
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Texas
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Odessa TX 79762
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Simply to Help —Helping You To
Keep More Of What You Earn and Helping You To Protect What You Keep
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Help To Keep Your Life In Balance
Bob Parrish
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Revised: February 26, 2007 .
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