From: Bob Parrish CPA PC
Sent: Friday, April 09, 1999 12:15 PM
To: Those interested in Family Limited Partnership compliance
Cc: None
Subject: Gifts of Limited Partnership Interests.html

Summary - Full Text - Issue - Facts - Law - Analysis - Conclusion - Warning & Disclaimer -

The following is a copy of a response from the Internal Revenue Service regarding those taxpayers making gifts to family members of the interest in a limited partnership or an limited liability company.

I will remind my clients wanting to be successufl with this strategy:  The transfer must constitute a "completed gift".  Failure to make distributions of cash from the FLP will place the entire objective in peril.    If you or the managing partner do not distribute at lease a portion of the annual earnings, the gift may not qualify and the result will not meet your objectives.

LTR 9751003
Section 2503 -- Taxable Gifts
UIL Number(s) 2503.03-00

Summary
"Gifts of Limited Partnership Interests Not Eligible for Annual Exclusion"

The Service has ruled in technical advice that gifts of limited partnership interests are gifts of future interests and do not qualify for the annual gift tax exclusion.

The donor is a widow with no children who owned several acres of land with a leased industrial building. She formed a limited partnership and transferred a 95 percent interest in the building to the partnership for a limited partnership interest. She also transferred the remaining 5 percent interest in the building to an S corporation in which she was the sole shareholder. The corporation then transferred its interest in the building to the partnership in exchange for a general partnership interest. Over a period of a couple of years, the donor gifted limited partnership interests to 35 family members and trusts for the benefit of family members who were minors.

The partnership agreement provides for income to be distributed to the limited partners in the complete discretion of the general partner and allows the general partner to retain income "for any reason whatsoever." As a result, said the IRS, it was uncertain at the time of the gifts whether any income would be distributed to the limited partners. For this reason, said the Service, the income component of the limited partnership interests is not a present interest for section 2503(b).

The partnership agreement also contains restrictions that prohibit the limited partners (other than the donor) from taking various actions. For instance, they cannot transfer or assign the gifted interests, nor can they withdraw from the partnership or receive a return of capital contributions until the year 2022. Also, no person can become a substituted limited partner without approval by 50 percent of the partnership interests together with the approval of the donor. An economic right requiring joint action with others, said the Service, is a contingent right regarded as a future interest.

The Service concluded that although title is vested in the donees, the limited partnership interests lack the tangible and immediate economic benefit required under section 2503(b) for a present interest in property and ruled the gifts are gifts of future interests that do not qualify for the annual exclusion.

Full Text

Date: august 28, 1997

Control No.: TAM-100711-97

Taxpayer's Name:
Taxpayer's Address:
Date of gift:
Conferences held:
(by telephone)

LEGEND:
Donor = * * *
Limited Partnership = * * *
Corporation = * * *
Building 1 = * * *
Building 2 = * * *
State = * * *

ISSUE
[1] Do the gifts of limited partnership interests made by the Donor qualify for the annual exclusion provided for in section 2503(b) of the Internal Revenue Code?

FACTS
[2] Donor is a widow with no children. Prior to the transactions described below, she owned several acres of land with a leased industrial building (Building 1), valued at approximately $2.4 million, and a second building (Building 2), valued at approximately $110,000.

[3] On December 30, 1991, when she was 71 years old, Donor gifted a one-eleventh interest in Building 2 to each of 11 family members. On January 1, 1992, the 11 family members reallocated their interests in Building 2 so that each of the four "family units" representing Donor's 4 siblings (one was deceased), owned a one- quarter interest in Building 2.

[4] On September 24, 1992, Donor set up an S corporation (Corporation) to which she transferred $9,800 in cash. Donor was the sole shareholder of Corporation. On September 25, 1992, Donor created 7 trusts, one each for the benefit of her 7 grandnieces and grandnephews who were minors. The initial corpus of each trust was $10.

[5] On December 22, 1992, the Donor formed the Limited Partnership under State's revised limited partnership act. On December 31, 1992, all of the following occurred:

[6] Donor transferred a 94.77-percent interest in Building 1 to the Limited Partnership and received a 90.6-percent limited partnership interest. Donor transferred the remaining 5.23-percent interest in Building 1 to the Corporation. The Corporation transferred its 5.23-percent interest in Building 1 to the Limited Partnership and received a 5-percent general partnership interest. The 11 members of Donor's family who owned Building 2 transferred their 100-percent interest in Building 2 to the Limited Partnership and received, as a group, a 4.4-percent limited partnership interest.

On the same day, Donor gifted a 29-percent limited partnership interest, in varying percentages, to 35 family members and trusts for the benefit of family members who were minors. Each of the four family units was given a total 7.25-percent interest. On the same day, five donees from one family unit, which consisted of 10 donees, assigned a part or all of their gifted partnership interests to three other donees of the family unit -- one adult and two trusts for minors.

[7] On March 10, 1993, the following occurred: The partners consented to the intra-family assignments of December 31, 1992. Donor gifted a 42-percent limited partnership interest, in varying percentages, to the same 35 family members and trusts for the benefit of family members who were minors. Each of the four family units was given a total 10.50-percent interest. Donor valued each 1-percent limited partnership interest at $9,900. The same five donees from the one family unit assigned a part or all of their gifted partnership interests to the same three donees within the family unit.

[8] In November 1993, Donor and Corporation made capital contributions to the Limited Partnership in the amounts of $283,027 and $14,896, respectively. The purpose of these contributions was to enable the Limited Partnership to purchase a tract of land. As a result of the contribution, Donor's limited partnership interest increased to 27.6 percent. Corporation remained the 5-percent general partner.

[9] On January 1, 1994, the following occurred: The partners consented to the intra-family assignments of March 10, 1993. Donor gifted her remaining 27.6-percent limited partnership interest, in varying percentages, to the 35 family members and trusts for the benefit of minor family members. Each of the four family units was given a total 6.90-percent interest. Donor valued each 1-percent limited partnership interest at $12,300. The same five donees from the one family unit assigned a part or all of their gifted partnership interests to the same three donees within the family unit.

[10] Following these transfers, members of Donor's family owned a 95-percent limited partnership interest and Donor's wholly owned Corporation owned a 5-percent general partnership interest.

[11] The Limited Partnership agreement contains the following provisions with respect to the limited partnership interests:

(1) CONCERNING DISTRIBUTIONS OF INCOME: Section 5.1: the General Partner may distribute funds of the partnership to the partners at such times and in such amounts as the General Partner, in its sole discretion, determines to be appropriate. Without limiting the generality of the foregoing, the General Partner shall have complete discretion to retain funds within the partnership for future partnership expenditures OR FOR ANY OTHER REASON WHATSOEVER. [Emphasis supplied.]

(2) CONCERNING WITHDRAWAL/RETURN OF CAPITAL CONTRIBUTIONS - Section 3.2: [No right to withdraw or receive capital unless otherwise specified in the agreement.]

Section 7.4: No Limited Partner shall be entitled to . . . the return of its Capital Contributions except to the extent, if any, that distributions made pursuant to the express terms of this Agreement may be considered as such by law or upon dissolution and liquidation of the Partnership, and then only to the extent expressly provided for in the Agreement and as permitted by law.

Section 7.4: No Limited Partner shall be entitled to . . . withdraw from the Partnership except upon the assignment by it of all of its Partnership Interest IN ACCORDANCE WITH SECTION 10.2. [Emphasis supplied.]

(3) CONCERNING TRANSFERS OF THE INTERESTS: Section 10.2: Except as provided in this Article to the contrary, no Limited Partner's interest in the Partnership shall be assigned, mortgaged, pledged, subjected to a security interest or otherwise encumbered, in whole or in part, and any attempt by any Limited Partner to assign or otherwise encumber its interest shall be void ab initio. Notwithstanding the preceding sentence, [Donor] may, at any time and from time to
time . . . transfer and assign her interest in the partnership by written instrument . . .

(4) CONCERNING SUBSTITUTION OF LIMITED PARTNERS: Section 10.3. No person may become a Substituted Limited Partner except an assignee who complies with this Section 10.3. No assignee of a Partnership Interest of a Limited Partner or any portion thereof shall have the right to become a Substituted Limited Partner unless all of the following conditions are satisfied:

(a) the assignor executes a written instrument of assignment together with such other instruments as the General Partner may deem necessary to effect the admission of the assignee as a Substituted Partner;

(b) such instrument has been delivered to, received and approved in writing by the General Partner; and

(c) the Super Majority Vote of the Partners (which must also include the vote of the General Partner) to such substitution has been obtained, the granting or denial of which shall be within the sole discretion of each Partner.

[12] A Super Majority Vote of the partners means (i) so long as Donor or her estate is a limited partner, a vote of Donor, or her estate, together with the vote of the partners holding at least 50 percent of the partnership interests held by partners other than Donor or her estate, or (ii) if neither Donor nor her estate is a limited partner, a vote of the partners holding at least 67 percent of the partnerships interests.

[13] At issue are the Donor's gift tax returns for the 1993 and 1994 tax years. In each year, Donor claimed an annual exclusion for each of the gifts of limited partnership interests made to the family members and trusts for the benefit of minor family members.

LAW
[14] Section 2501 provides that a tax is imposed on the transfer of property by gift.

[15] Section 2503(a) provides that the term "taxable gifts" means the total amount of gifts made during the calendar year.

[16] Section 2503(b) provides that in the case of gifts (other than gifts of future interests in property) made to any person by the donor during the calendar year, the first $10,000 of such gifts to such person shall not, for purposes of subsection (a), be included in the total amount of gifts made during such year.

[17] Section 25.2503-3(a) of the Gift Tax Regulations provides that no part of the value of the gift of a future interest may be excluded in determining the total amount of gifts made during the "calendar period." "Future interest" is a legal term, and includes reversions, remainders, and other interests or estates, whether vested or contingent, which are limited to commence in use, possession or enjoyment at some future date or time.

[18] Section 25.2503-3(b) provides that an unrestricted right to the immediate use, possession, or enjoyment of property, or the income from property is a present interest.

[19] Under State law applicable in this case, a limited partnership interest is assignable in whole or in part, unless otherwise provided in the partnership agreement. A limited partner may withdraw only at the time specified in the agreement. Ordinarily, a general partner is a fiduciary with respect to the limited partners. See McLendon v. McLendon, 862 S.W.2d 662 (1993).

ANALYSIS
[20] The issue presented is whether the limited partnership interests gifted by Donor are gifts of a present interest in property. As stated by the Supreme Court, "[t]he question is of time, not when title vests, but when enjoyment begins." Fondren v. Commissioner, 324 U.S. 18, 20 (1945). It is not enough that the donee has vested rights; he must also have the present right to use, possess or enjoy the property. In other words, the donee must have the right to a substantial present economic benefit. Id; see also Commissioner v. Estate of Holmes, 326 U.S. 480 (1946).

[21] For purposes of section 2503(b), a gift may be separated into its component parts, one of which may qualify as a present interest, others of which may not. Thus, if the component comprising the capital or corpus of the gift does not satisfy the present interest requirements, but the element comprising the income rights does, an annual exclusion may be allowed for the gift of the income rights. Fondren v. Commissioner, supra at 21; Commissioner v. Disston, 325 U.S. 442 (1945). Nevertheless, a right to income is a present interest only if, at the time of the gift, there is a requirement for a steady and ascertainable flow of income to the donee. Commissioner v. Disston, supra at 449; Maryland National Bank v. United States, 609 F.2d 1078 (4th Cir. 1980); Calder v. Commissioner, 85 T.C. 713 (1985).

[22] In this case, the partnership agreement provides for income to be distributed to the limited partners in the "complete discretion" of the general partner. The general partner may retain funds within the partnership for future partnership expenditure. Further, the general partner may retain funds FOR ANY REASON WHATSOEVER. This provision for the general partner's retention of income "for any reason whatsoever" is extraordinary and outside of the scope of a business purpose restriction. The provision effectively obviates the fiduciary duty ordinarily imposed upon a general partner, and clothes the general partner with the authority to withhold income for reasons unrelated to the conduct of the partnership.

[23] Consequently, it was uncertain, at the time of the gifts, whether any income would be distributed to the limited partners. For this reason, the income component of the limited partnership interests failed to require, at the time of the gifts, that there be a steady and ascertainable flow of income to a donee/limited partner. Because the income component of the limited partnership interests did not entitle the donees to the immediate use, possession or enjoyment of the income, the income component was not a present interest for purposes of section 2503(b).

[24] The limited partnership interests also were subject to restrictions, contained in the limited partnership agreement, that prohibited certain actions that might otherwise be taken by limited partners. For example, under the agreement, the donees could not transfer or assign the gifted interests; nor could they withdraw from the partnership or receive a return of capital contributions until the year 2022. Section 7.4 of the agreement provides that a Limited Partner may assign its partnership interest only in accordance with section 10.2. It is clear from section 10.2 that only the Donor could assign limited partnership interests. This being the case, section 10.3 must be read to apply only to assignees of the Donor. The fact that all partners consented to the intra-family assignments of December 31, 1992, and March 10, 1993, does not void this provision of the partnership agreement.

[25] Moreover, an economic right requiring joint action with others is a contingent right regarded as a future interest. Ryerson v. United States, 312 U.S. 405 (1941); Blasdel v. Commissioner, 478 F.2d 226 (5th Cir. 1973); Chanin v. United States, 393 F.2d 972 (Ct. CI. 1968). Thus, the right of a limited partner to join with other partners to liquidate the partnership does not change the character of the interest as a future interest.

[26] In the present case, although title vested in the donees, the limited partnership interests lacked the tangible and immediate economic benefit required under section 2503(b) for a present interest in property. See e.g., Hamilton v. United States, 553 F.2d 1216 (9th Cir. 1977); Berzon v. Commissioner, 534 F.2d 528 (2d Cir. 1976).

[27] Thus, regardless of whether the components of the gifted limited partnership interests are considered separately or together, the gifts failed to confer on the donees the substantial present economic enjoyment required under section 2503(b) for a present interest.

CONCLUSION

[28] The gifts of limited partnership interests are gifts of future interests and, therefore, do not qualify for the annual exclusion under section 2503(b).

[29] A copy of this Technical Advice Memorandum should be given to the taxpayer. Section 6110(j) provides that it may not be used or cited as precedent.

WARNING AND DISCLAIMER

THIS IS FOR INFORMATION AND EDUCATION PURPOSES ONLY.  YOU MUST SEEK ADEQUATE PROFESSIONAL ASSISTANCE BEFORE TAKING AND NOT TAKING ANY ACTION.  THIS WAS TAKEN FROM SOURCES BELIEVED TO BE ACCURATE BUT NO WARRANTY IS EXPRESSED OR IMPLIED.

[ flp private letter ruling 9751003 ]