| Code Secs. 2036, 2038, 2503, 2701 |
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| * Sec. 2036 Issues: Transfers with retained life estate
(included v. not included in gross estate). |
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| * Sec. 2038 Issues: Revocable transfers (included v. not
included in gross estate). |
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| * Sec. 2503 Issues: Taxable gifts (annual exclusion
allowed v. not allowed). |
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| * Sec. 2701 Issues: <
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| This is in response to your December 8,
1993 letter requesting rulings |
| under sections 2036, 2038, 2503, and 2701 of the
Internal Revenue Code |
| with respect to proposed transfers of limited
partnership interests by a |
| general partner. |
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| The Transferor and his wife
created the limited partnership |
| (Partnership) in 1993. The Transferor initially
contributed cash to the |
| Partnership in exchange for a 9.259 percent general
partnership interest |
| and a 90.278 percent limited partnership interest.
The Transferor's wife |
| initially contributed cash in exchange for a 0.463
percent limited |
| partnership interest. Subsequently, the trustees of
certain trusts for the |
| benefit of the Transferor's family and a custodian
under a uniform gifts |
| to minors act account invested additional funds in
the Partnership in |
| exchange for limited partnership interests. |
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| The Transferor as general partner
has exclusive management control of |
| the Partnership, including full discretion to
determine the amount and |
| timing of distributions to the partners; provided,
however, that if the |
| general partner directs the distribution of
partnership funds to the |
| partners, distributions must be made to all partners
at the same time in |
| accordance with each partner's percentage interest
in the Partnership |
| (based on each partner's capital account). |
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| Under the terms of the partnership
agreement and applicable state law, |
| the Transferor as general partner has a fiduciary
duty to the limited |
| partners to manage and operate the Partnership in
the best interests of |
| the Partnership and its partners. In exercising the
powers granted in the |
| partnership agreement, the general partner is bound
to act in accordance |
| with this fiduciary duty. |
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| The partnership agreement provides
that all items of income and |
| deductions are to be allocated in accordance with
the principles of |
| section 704(b) and the regulations thereunder. |
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| During the term of the
Partnership, no partner is entitled to demand a |
| distribution or a return of his capital account.
However, the partners |
| have the right to sell their interests to third
parties, subject to the |
| right of first refusal granted to the other
partners. |
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| When the partnership is dissolved,
its assets will be distributed to |
| the partners on a pro rata basis in accordance with
their respective |
| partnership interests. |
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| The transferor proposes to make
gifts of limited partnership interests. |
| If the transferor desires to have a particular gift
qualify for the |
| $10,000 annual exclusion under section 2503(b), he
will make the transfer |
| either outright or to a trustee of a trust that
meets the requirements of |
| section 2503(c). |
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| You request that we rule as
follows: |
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| 1. The Transferor's proposed
transfers (outright or to S trusts |
| qualifying under section 2503(c)) of limited
partnership interests will |
| constitute gifts of present interests for purposes
of section 2503(b). |
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| 2. The value of the limited
partnership interests gratuitously |
| transferred will not be subject to the special
valuation rules under |
| section 2701. |
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| 3. Upon the death of the
Transferor, the value of the transferred |
| partnership interests will not be includible in the
Transferor's gross |
| estate under sections 2036 or 2038 as a result of
the Transferor's |
| retained powers as general partner. |
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| ISSUE 1 |
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| Section 2501(a)(1) provides for
the imposition of a tax on the transfer |
| of property by gift. Section 2511 provides that 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. |
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| Section 2503(b) provides that in
the case of gifts (other a 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 be included in the total amount of gifts
made during such year. |
| The annual exclusion is only allowed for gifts of
present interests in |
| property. Section 25.2503-3(b) of the
Gift Tax Regulations provides that |
| a present interest in property is an unrestricted
right to the immediate |
| use, possession, or enjoyment of the property (such
as a life estate or a |
| term certain). |
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| Section 25.2503-3(a) of the
regulations defines "future interests" as a |
| legal term that includes reversions, remainders, and
other interests or |
| estates, whether vested or contingent, and whether
or not supported by a |
| particular interest or estate, which are limited to
commence in use, |
| possession, or enjoyment some future date or time. |
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| Section 2503(c) provides that no
part of a gift to an individual who |
| has not attained the age of 21 on the date of the
transfer shall be |
| considered a gift of a future interest for purposes
of section 2503(b) if |
| the property and the income therefrom (1) may by
expended by, or for the |
| benefit of, the donee before he attains the age of
21 and (2) will, to the |
| extent not so expended, pass to the donee upon his
attaining age 21 or be |
| payable to his estate or as he may appoint under a
general power of |
| appointment in the event that he dies before
attaining age 21. |
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| In the subject case, the
management powers possessed by the |
| Transferor/general
partner under the partnership agreement, including |
| control over partnership distributions, are similar
to the powers |
| possessed by general partners in most limited
partnerships. A general |
| partner must exercise such powers in a fiduciary
capacity and is held to a |
| high standard of conduct toward the limited
partners. See generally, In re |
| USACafes, L.P. Litigation, 600 A.2d 42 (Del. Ch.
1991), and A.B. Willis, |
| J.S. Pennell, P.G. Postlewaite, Partnership Taxation
(4th Ed. 1989), |
| section 1.05. Thus, in the subject case, the general
partner's powers are |
| not the equivalent of a trustee's discretionary
authority to distribute or |
| withhold trust income or property (i.e., a power
that generally results in |
| the characterization of a gift to such a trust as a
gift of a future |
| interest). |
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| In the subject case, the proposed
gifts of limited partnership |
| interests will constitute outright gifts of
ownership interests in a |
| business entity. Each donee will receive the
immediate use, possession, |
| and enjoyment of the subject matter of the proposed
gifts, including the |
| right to sell or assign the interest (subject to the
right of first |
| refusal). |
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| Accordingly, we conclude that the
proposed gifts of limited partnership |
| interests by the Transferor will constitute gifts of
present interests |
| that will qualify for the annual exclusion under
section 2503(b). |
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| ISSUE 2 |
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| Section 2701 provides that special
valuation rules are applicable to a |
| transfer of an interest in a corporation or
partnership to a member of the |
| transferor's family if the transferor or an
applicable family member |
| retains an "applicable retained interest." |
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| The term "applicable retained
interest" is defined in section |
| 25.2701-2(b)(1) to include (among other things) an
equity interest that |
| constitutes a "distribution right" (as
defined in section 25.2701-2(b)(3)) |
| in a "controlled entity" (as defined in
section 25.2701-2(b)(5). |
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| Section section 25.2701-2(b)(5)
provides in part that, for purposes of |
| section 2701, a "controlled entity"
includes a partnership controlled, |
| immediately before a transfer, by the transferor,
applicable family |
| members, and any lineal descendants of the parents
of the transferor or |
| the transferor's spouse. Section
25.2701-2(b)(5)(iii) provides in part |
| that, in the case of a limited partnership,
"control" means the holding of |
| any equity interest as a general partner. Thus, in
the subject case, the |
| Partnership is a "controlled entity" vis a
vis the Transferor because of |
| his status as a general partner. |
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| Having concluded that the
Partnership is a "controlled entity" vis a |
| vis the Transferor/general
partner, the question remains whether the right |
| to
distributions from the Partnership that the
Transferor/general partner |
| proposes to retain are "distribution
rights" within the meaning of section |
| 2701(c)(1) and section 25.2701-2(b)(3). If the
retained rights are not |
| "distribution rights," the requisite
"applicable retained interest" will |
| not exist and, as a consequence, section 2701 will
not apply. |
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| Section 25.2701-2(b)(3)(i)
provides that a "distribution right" does |
| not include any right to receive distributions with
respect to an interest |
| that is of the same class as the transferred
interest. Under section |
| 25.2701-1(c)(3), a retained interest is in the same
class as the |
| transferred interest if the rights in the retained
interest are identical |
| to the rights of the transferred interest except
for, in the case of a |
| partnership, non-lapsing differences with respect to
management and |
| limitations on liability. For this purpose,
non-lapsing provisions |
| necessary to comply with partnership allocation
requirements of the |
| Internal Revenue Code (e.g., section 704(b)) are
non-lapsing differences |
| with respect to limitations on liability. |
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| In the subject case, the right to
distributions that the |
| Transferor/general
partner proposes to retain are rights with respect to |
| an interest that is of the same class as the
interests that he proposes to |
| transfer. Consequently, the rights to be retained by
the Transferor will |
| not constitute "distribution rights."
Thus, an "applicable retained |
| interest" will not exist after the proposed
transfers, and section 2701 |
| will not apply. |
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| ISSUE 3 |
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| Section 2036(a) provides that a
decedent's gross estate includes the |
| value of all property to the extent of any interest
therein of which the |
| decedent has at any time made a transfer (except in
case of a bona fide |
| sale for an adequate and full consideration in money
or money's worth) by |
| trust or otherwise under which he has retained, for
his life or for any |
| period not ascertainable without reference to his
death or any period that |
| does not in fact end before his death, (1) the
possession or enjoyment of, |
| or the right to the income, from the property, or
(2) the right, either |
| alone or in conjunction with any person, designate
the persons who shall |
| possess or enjoy the property or the income
therefrom. |
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| Section 2036(b) provides that, for
purposes of section 2036(a)(1) the |
| retention of the right to vote, directly or
indirectly, shares of stock of |
| a controlled corporation shall be considered a
retention of the enjoyment |
| of the transferred property. |
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| In United States v. Byrum, 408
U.S. 125 (1972), 1972-1 C.B. 518, the |
| decedent was a controlling shareholder and a member
of the board of |
| directors of a closely-held corporation. The Court
held that stock in the |
| corporation transferred by the decedent to an
irrevocable trust was not |
| included in his gross estate under section 2036 even
thought the decedent |
| expressly retained the right to vote the transferred
stock and to veto the |
| sale or disposition of the stock by the trustee. The
Court held that the |
| decedent, as a controlling shareholder and a member
of the board of |
| directors, had a fiduciary duty to promote the
interests of the |
| corporation and not to exercise his voting power to
promote his personal |
| interests at the expense of the minority
shareholders. Accordingly, the |
| decedent's retained power to vote the stock did not
constitute the |
| retained enjoyment of the transferred stock or right
to designate the |
| income from the transferred stock for purposes of
section 2036. |
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| As indicated above, the Transferor
in the subject case is the general |
| partner of the Partnership and as such has
management authority over the |
| Partnership, including the authority to control
partnership distributions. |
| However, as in the case of the decedent in Byrum,
the Transferor in the |
| subject case occupies a fiduciary position with
respect to the limited |
| partners and cannot distribute or withhold
distributions or otherwise |
| manage the partnership for purposes unrelated to the
conduct of the |
| partnership business. |
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| Section 2038 provides that the
value of the gross estate shall include |
| the value of all property of which the decedent has
at any time made a |
| transfer (except in case of a bona fide sale for an
adequate and full |
| consideration in money or money's worth) in trust or
otherwise, where the |
| enjoyment thereof was subject to a power in the
decedent to alter, amend, |
| revoke, or terminate such interest or where any such
power was |
| relinquished during the 3-year period ending on the
date of the decedent's |
| death. Based upon the foregoing analysis with
respect to section 2036, the |
| Transferor's fiduciary duty with respect to the
management of the |
| Partnership will also preclude an inclusion in his
gross estate under |
| section 2038. |
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| Accordingly, we conclude that the
value of the partnership interests |
| proposed to be transferred by the Transferor will
not be includible in his |
| gross estate under sections 2036 or 2038 by reason
of his status as |
| general partner. |
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| This ruling is based on the facts
and applicable law in effect on the |
| date of this letter. If there is a change in
material fact or law (local |
| or federal) the ruling will have no force or effect.
If the taxpayer is in |
| doubt whether there has been a change in material
fact or law, a request |
| for reconsideration of this ruling should be
submitted to this office. |
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| This ruling is directed only to
the taxpayer who requested it. Section |
| 6110(j)(3) provides that it may not be used or cited
as precedent. |
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