October 11, 2011
Appeals Court Upholds Charity Gift Tax Avoidance Technique
One common strategy to transfer wealth to family members without exceeding the lifetime gift tax exclusion is to place that wealth in a limited liability company and then to transfer minority interests in that LLC to the beneficiaries, valuing those interests at a substantial discount because they lack control over the LLC. The IRS often challenges the amount of the discounts, usually leading to a final, reduced discount amount. Absent any adjustments in the interests transferred, such a reduction would increase the value of the transferred interests and so likely result in significant gift taxes owed. One possible way to avoid such a result is to create a "charitable freeze" that shifts any amount above the gift tax exclusion to a charitable beneficiary if such a discount reduction occurs, thereby arguably avoiding any gift tax and related interest and penalties.
The issue in Estate of Anne Y. Petter v. Commissioner was whether this technique actually works. The Tax Court held it did, and the U.S. Court of Appeals for the Ninth Circuit affirmed that decision. The appellate court concluded that this structure did not create a condition precedent on the (increased) transfer to the recipient charity, and so even though the change in the transfer amount would not have occurred absent the IRS audit the effect of the audit was simply to make sure the charities at issue received what they were always entitled to receive under the applicable documents. At the same time, however, the court explicitly left open the door for the Treasury Department to amend its regulations to forestall the use of this technique in the future (see last page of the opinion).
Coverage: Wall Street Journal.
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