Code Sec. 2503

* Sec. 2503 Issues: Taxable gifts (annual exclusion allowed v. not

allowed) -- Present v. future interests.

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ISSUE

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

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.

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.

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.

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:

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.

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.

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.

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.

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.

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.

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.

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

Section 2501 provides that a tax is imposed on the transfer of property

by gift.

Section 2503(a) provides that the term "taxable gifts" means the total

amount of gifts made during the calendar year.

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.

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.

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.

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

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).

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).

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.

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).

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.

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. Cl. 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.

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).

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

The gifts of limited partnership interests are gifts of future

interests and, therefore, do not qualify for the annual exclusion under

section 2503(b).

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.

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