Welcome to TaxView, with Chris Moss CPA
Death tax is a fact of life, or death, as the case may be, and death taxes have been taxing estates for thousands of years. Euphemistically referred to as “estate tax”, the tax is assessed when assets are transferred to your beneficiaries on that special day of your departure over the tax free IRS allowed exemption. Despite the fact that Congress likes to adjust this exemption from time to time, if your tax attorney “guessed” right as to what the tax free exemption will be when you die, your estate pays no tax, if she guessed wrong….well your kids just might have to sell the farm to pay the estate tax. Best practice is to gift to your Family Limited Liability Company (LLC) up to the IRS annual 2014 exclusion of $14,000 per person ($28,000 if married) which reduces by the same the amount of the value of your estate. Sounds easy, but beware of the IRS tax traps waiting for the unwary beginner. So you had better stay with us on TaxView with Chris Moss CPA for an exciting journey to the beginner’s world of estate and gift tax planning so you can keep your assets legally safe from taxation for many generations to come.
First, if you don’t yet have a Family LLC I recommend you first read my article on the Family LLC as well as read my article on Family LLC Discounts. You can make up to $28,000(married) in 2014 tax free gifts a year to each of your children. If you are married and have two children age 10 by the time they are both 20 each will have $280,000 worth of membership in your family LLC. In addition to the annual gift exclusion of $28,000, you can also make lifetime gifts of $5M ($10M married) but these gifts require the filing of a gift tax return with the IRS. Any gifts over the $10 Million are taxable, either as gifts if you are alive or as estate tax if you are dead. Because Congress frequently changes these exemptions and exclusions, best practice requires annual review of your estate plan by your tax attorney to make sure your unique plan complies with current law. Sounds simple but not really. In addition to ever changing exclusion and exemptions amounts, there are many death traps awaiting you as you create the family LLC.
The first trap we are going to cover today is released with a trap question: When is a gift not a gift? To answer this question we head on over to US Tax Court to listen in on a 2013 Tax Court case Estate of Sommers v IRS. Sommers was a successful physician who owned a valuable collection of art. Sommers retained the services of a B&T Tax Attorney who advised Sommers in 2001 to get the art appraised, create an LLC as owner of the art and gift LLC units to his three nieces, Wendy Julie and Mary up to the maximum allowed exemption ($675K at that time) to avoid Sommers of having to pay gift tax. However, after the appraisal came in over the exemption and gift tax was owed, the nieces paid the gift tax themselves to avoid any breach of the agreement and more importantly to reflect that the parties carried out the original intent of the agreement that Sommers pay no gift tax.
Fast forward a few years and Sommers (or perhaps other relatives of Sommers) changed their minds about gifting the art to Wendy, July and Mary, but the nieces refused to give the art back to Sommers. After Sommers died, his executor sued the nieces for the art in various State court actions claiming that the gift agreement was illegally altered when the appraisal came in over the allowed exemption. Even though the estate eventually lost in state court, it’s legal executor nevertheless included the value of the art as part of the estate tax return on Form 706. The IRS rejected this return noting that Form 709 a US Gift tax return had been filed years earlier in 2001 for these same works of art. Sommers estate appealed to US Tax Court. Estate of Sommers vs IRS. Judge Halpern sided with the IRS noting that Sommers did not retain the power to “alter, amend, revoke or terminate those gifts within the meaning of IRS Section 2038 and therefore, the gifts were valid and had to be removed from Summers estate. IRS (and nieces) win, Estate of Sommers and other relatives lose.
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The second trap we are going to look at today is found in the Operating Agreement of the LLC as highlighted in the US Tax case of Hackl v IRS. Hackl was a successful executive with Herff Jones Inc. in Georgia. Upon his retirement in 1995 he started a tree farming business with his wife in both Georgia and Florida. Treeco LLC was created with both Mr and Mrs Hackl owning 50% each. The LLC operating agreement designated Hackl as the initial manager to serve for life and had very restrictive buy sell provisions. One such restrictive provision required each new member to get Hackl’s permission before they could sell their membership, even if the sale was between brothers and sisters. Shortly thereafter, Hackl gifted various membership interests in Treeco to each of his eight (8) children and spouses and timely filed gift tax returns to the IRS claiming the gifts qualified for the annual exclusion under IRS Code 2053(b). The IRS audited the 1996 gift tax return in 2000 and disallowed the exclusions claiming the gifts were future interest gifts and had no present value. Hackl appealed to US Tax Court in 2002 Hackl v IRS claiming the gifts were in fact gifts and had real substantial present value. Judge Nims points out that for Hackl to win his children must have an unrestricted right to the immediate use possession or enjoyment of the property or the income from property within the meaning of IRS Section 2503(b). The Court agreed with the IRS that due to the severe operating agreement restrictions the children never received a “present” interest in the LLC memberships they received. IRS wins, Hackl Loses.
What does that mean for all of us? If you are planning to gift the current $28,000 (married) annual exclusion to your children through your Family LLC make sure you and your tax attorney create an operating agreement for the children that can withstand Government scrutiny regarding “present interest” in the event of an IRS audit. Second, if you are gifting large gifts over the $28,000 annual exclusion either less than or in excess of the current $10M exemption (married) make sure you file all gift tax returns and pay any gift tax you owe to make sure the gift cannot be revoked or amended by other not so happy relatives after your death. Finally, develop a long range estate and gift tax plan with your tax attorney so that when your final day comes you can keep your assets legally safe from estate taxation to assist your children and preserve your wealth for many generations to come. Thank you for joining us on TaxView with Chris Moss CPA.
Kindest regards and see you next time,
Chris Moss CPA
