Five Recent Cases Reveal Continuing Uncertainties in the Treatment of
Transfers of FLP and LLC Interests for Estate and Gift Tax Valuation Purposes
Federal courts recently issued five opinions concerning the federal estate
and gift tax treatment of transfers of interests in family limited partnerships
and limited liability companies (FLPs or LLCs) to family members. The first
three cases deal with the issue of the lifetime gifts of interests in FLPs and
LLCs, and whether these are gifts of FLP and LLC interests at a discounted basis
or gifts of the underlying assets in the FLP or LLC without discounts.
- Linton v. United States, 2009 U.S. Dist.
LEXIS 56604 (W.D. Wash. July 1, 2009) – The Western District of Washington
found that taxpayer parents made indirect gifts of an LLC’s assets to their
children’s trusts when the FLP was funded on the same day that the LLC
interests were transferred to their children’s trusts. The step transaction
doctrine also applied.
- Heckerman v. United States, 2009 U.S.
Dist. LEXIS 65746 (W.D. Wash. July 27, 2009) – Another Western District of
Washington trial court case with similar facts to Linton produced the
same outcome as in Linton.
- Pierre v. Comm’r, 133 T.C. No. 2 (Aug. 24,
2009) – The Tax Court held that the check-the-box regulations did not cause
a LLC to be disregarded for purposes of determining the value of the donor’s
transferred LLC interests and the donor’s corresponding federal gift tax
The last two cases deal with the valuation of FLP and LLC interests in a
- Keller v. United States, 2009 U.S. Dist.
LEXIS 73789 (S.D. Tex. Aug. 20, 2009) – In a remarkable taxpayer victory, a
Texas trial court allowed significant valuation discounts for FLP interests
held by taxpayer’s estate where the taxpayer demonstrated a non-tax purpose
for forming the FLP even though the FLP was formed shortly before the
decedent’s death but not funded until more than a year after the decedent’s
- Malkin v. Comm’r, T.C. Memo 2009-212 (Sept.
16, 2009) – The taxpayer lost on most issues where the court determined that
the taxpayer had retained beneficial enjoyment of stock used to fund two
FLPs under section 2036(a). The taxpayer was also found to have made
indirect gifts of LLC assets, cash, and a promissory note to his children.
Linton v. United States, 2009 U.S. Dist. LEXIS
56604 (W.D. Wash. July 1, 2009)
In Linton, a husband and wife sought a partial refund of federal gift
taxes paid on transfers of interests in their LLC to trusts created for the
benefit of their children. In November 2002, Mr. Linton formed an LLC and was
its only member. On Jan. 22, 2003, Mr. Linton gave a 50% interest in the LLC to
On the same day, the Lintons executed the following documents to fund the
LLC: (i) a quit claim deed for real property; (ii) letters of authorization for
transfers of securities and cash; and (iii) an assignment of assets. Also on
Jan. 22, 2003, the Lintons signed separate trust agreements establishing a trust
for each of their four children. They also signed “gift of percentage interest”
documents that transferred 22.5% of the Lintons’ interests in the LLC to each
child’s trust. On their 2003 gift tax returns, the Lintons claimed a 47%
discount on the value of the transferred interests attributable to a lack of
marketability and control which rendered the LLC interests unmarketable.
On the Internal Revenue Service’s (Service) motion for summary judgment, the
court considered testimony offered by the Lintons to establish a chronology of
events favorable to the taxpayers. However, the court found that the evidence
offered by the Lintons was insufficient to overcome the express language of the
trust and transfer documents. Specifically, the court found that the express
language of the children’s trust agreements and the LLC transfer documents
established that the trusts were created and the gifts to the trusts were made
on the same day.
The court further found that the Lintons failed to present evidence that
would justify a reformation of the trust agreements and gift documents to a date
nine days after the LLC was funded. The court concluded that the trusts were
validly created on Jan. 22, 2003, and that the Lintons made gifts of LLC
interests to the trusts on the same day. Therefore, the court, in comparing the
facts in the Lintons’ case to those in Shepherd v. Comm’r, 115 T.C. 376
(2000) and Senda v. Comm’r, 433 F.3d 1044 (8th Cir. 2006), found that the
Lintons had made pro rata indirect gifts of the LLC’s underlying assets to the
children’s trusts and not gifts of percentage interests in the LLC itself.
The court also found persuasive the Service’s alternative argument that the
Lintons made indirect gifts of LLC assets to the children’s trusts under the
step transaction doctrine. After setting forth the three generally recognized
step transaction tests (binding commitment, end result, and interdependence),
the court found that each test was satisfied. The binding commitment test was
satisfied when the Lintons executed the binding trust agreements and gift
documents at the same time the LLC was funded. The end result test was met
because the Lintons made prearrangements to maximize the value of the transfers
to their children while minimizing their federal gift tax liability when Mr.
Linton did not date the LLC gift documents in an attempt to ensure that the LLC
was funded before the gifts to the children’s trusts were effective.
Likewise, the court found that the interdependence test was satisfied where
the evidence showed that the Lintons would not have funded the LLC without the
anticipated valuation discount for the transfers to the trusts for the children.
The court further distinguished this case from the pro-taxpayer decisions in
Holman v. Comm’r, 130 T.C. 170 (2008) and Gross v. Comm’r, T.C. Memo
2008-221 (2008), where the taxpayers delayed making gifts for several days (six
days and eleven days respectively) after funding the underlying LLC.
Finding no genuine issue of material fact related to the Lintons’ transfers
of LLC interests to their children’s trusts, the court granted the Service’s
summary judgment motion, and held that the Lintons made an indirect gift of the
underlying assets in the LLC to their children’s trusts.
Heckerman v. United States, 2009 U.S. Dist.
LEXIS 65746 (W.D. Wash. July 27, 2009)
In Heckerman, a different judge in the Western District of Washington,
but on essentially the same theories advanced in Linton, accepted the
Service’s assertion that parents were not entitled to a refund of federal gift
tax where it was alleged that the parents had made indirect gifts to their two
On Nov. 28, 2001, Mr. and Mrs. Heckerman created trusts for their children.
That same day, the Heckermans created three limited liability companies: an
Investments LLC, a Real Estate LLC and a Family LLC (to serve as an umbrella for
the Investments and Real Estate LLCs). On Dec. 28, 2001, the Heckermans funded
the Real Estate LLC with a beach house located in Malibu, California. On Jan.
11, 2002, the Heckermans funded the Investments LLC with $2.85 million in mutual
funds. Also on Jan. 11, 2002, the Heckermans transferred just under 50%
interests in the Family LLC to each child’s trust. On Feb. 6, 2002, the
Heckermans obtained an appraisal report that valued the gift transactions as of
the date of transfer, Jan. 11, 2002. The Heckermans’ subsequent gift tax returns
for the transfers to the trusts reflected a 58% discount for the lack of
marketability of the LLC interests.
The Service asserted that the Heckermans’ contributions to Investments LLC
should be treated as indirect gifts to the children’s trusts. Alternately, the
Service argued that the step transaction doctrine should apply to the funding of
the LLC and the corresponding gifts of LLC interests. Significantly, the Service
did not argue that the Heckermans’ contribution of real estate to the LLC
on Dec. 28, 2001, was an indirect gift to the children’s trusts, when gifts of
LLC interests in the real estate were made fourteen days later.
The court rejected the Heckermans’ attempts to contradict the “overwhelming”
express written evidence that showed that the gifts of LLC interests were made
on the same day the LLC was funded. The court further disallowed the Heckermans’
attempt to argue that the gifts were not effective until the gifts were
delivered to the trustees, because the Heckermans failed to raise this argument
in their initial claim for refund. The court also found that the Heckermans
could not establish that their capital accounts were increased by the amount of
their contributions to Investments LLC that would entitle them to receive the
amount of their contributions from the entity in the event of its liquidation.
Like the court in Linton, the court in this case also found the step
transaction doctrine applicable to the transactions, since the funding of
Investments LLC and subsequent gifts of Family LLC interests to the children’s
trusts were “at best, integrated and, in effect, simultaneous.” The court found
that two of the three alternative step transaction tests – the end result test
and the interdependence test – were satisfied. Relying on Mr. Heckerman’s
testimony and an e-mail between Mr. Heckerman and his financial advisor, the
court found the end result test was met because the evidence showed Mr.
Heckerman’s intent to fund the LLC in a way that would not incur a federal gift
Additionally, in the court’s opinion, the interdependence test was satisfied
because the court determined that the Heckermans would not have funded
Investments LLC without the anticipated discount in valuation and corresponding
federal gift tax on the transfers of the LLC interests.
The court further distinguished the Heckermans’ case from Holman and
Gross, noting again that several days had passed in those cases between
the funding of the FLPs and the gifting of the FLP interests. Furthermore, the
court noted that unlike the taxpayers in Holman and Gross, the
Heckermans did not bear any real economic risk that the LLC units would change
value between the date of funding and the date of gifting. Accordingly, the
court granted the Service’s motion for summary judgment and held that the
Heckermans had made indirect gifts of the underlying assets in the LLC to their
children’s trusts with respect to the LLC’s assets.
Pierre v. Comm’r, 133 T.C. No. 2 (Aug. 24, 2009)
The Service assessed tax deficiencies on the taxpayer’s payment of federal
gift tax and generation-skipping transfer tax. The sole issue before the court
was whether interests transferred in a LLC that is a disregarded entity under
the “check-the-box regulations” found in Regulations sections 301.7701-1 through
301.7701-3 are valued as a proportionate share of the LLC’s underlying assets,
or are instead valued as transfers of LLC interests.
On July 13, 2003, Ms. Pierre created an LLC under New York law. She did not
elect to treat the LLC as a corporation for federal income tax purposes. On July
24, 2000, she created separate trusts for her son and granddaughter. On Sept.
15, 2000, she funded the LLC with $4.25 million in cash and securities. Then on
Sept. 27, 2000, through a combined gift and sale, Ms. Pierre transferred her
entire interest in the LLC to the trusts created for her family members. She
asserted a 36.55% valuation discount on the transfers for gift tax purposes.
The Service asserted that Ms. Pierre’s gifts of interests in the LLC were
actually gifts of the LLC’s underlying assets, and were not gifts of interests
in the entity itself. Likewise, the Service claimed that Ms. Pierre made gifts
to the trusts to the extent that the value of the underlying assets of the LLC
exceeded the amount of the promissory notes used to finance the sales from
herself to the trusts.
The Service asserted that the check-the-box regulations should cause the
transfers of interests in the LLC to be treated as transfers of the LLC’s
underlying assets, and not transfers of interests in the LLC for purposes of
valuing the transfers. Ms. Pierre contended that state law defines the nature of
property interests transferred for federal gift tax valuation purposes. She
further argued that under New York state law, a membership interest in a limited
liability company is personal property, and that LLC members do not have
specific interests in an LLC’s property.
The court considered whether the check-the-box regulations altered the
federal gift tax valuation regime. The court found that the check-the-box
regulations were used to classify an entity with a single owner
disregarded “for federal tax purposes.” However, a majority of the court’s
judges found that the check-the-box regulations did not require a single-member
LLC to be disregarded for federal tax purposes when valuing and taxing Ms.
Pierre’s transfers of ownership interests in the LLC.
The court determined that while the check-the-box regulations governed how a
single-member LLC is taxed for federal income tax purposes, the
regulations did not apply to disregard the LLC in determining how Ms. Pierre
as donor of the transferred interests should be taxed for federal gift tax
purposes. The court stated that if Congress intended for the check-the-box
regulations to apply as the Service asserted, Congress would enact such a
specific provision as it had elsewhere in the Code.
Accordingly, the court held that Ms. Pierre’s transfers of interests in the
LLC should be valued for federal gift tax purposes as transfers of interests in
the entity, and not as transfers of the entity’s underlying assets. The court
reserved judgment on related valuation issues and application of the step
transaction doctrine for a later opinion.
Keller v. United States, 2009 U.S. Dist. LEXIS
73789 (S.D. Tex. Aug. 20, 2009)
In Keller, the executors of the Estate of Maude O’Connor Williams
sought a refund of estate taxes paid based on a claimed 47.5 % valuation
discount of FLP interests held by the estate. In 1998, Mr. and Mrs. Williams
created a family trust to hold a pool of investment assets. The record showed
that Mrs. Williams was significantly concerned with protecting the family’s
assets from the claims of a non-blood relative, in the event of the divorce of a
family member. Following Mr. Williams’ death in 1999, Mrs. Williams began
considering the use of a series of FLPs to hold each class of the family’s
assets. The court found that the purpose of the FLPs was to consolidate and
protect the assets for management purposes, and to facilitate the transfer of
the assets to younger generations.
In September 1999, Mrs. Williams reviewed a spreadsheet identifying which
assets would fund the FLP. The general partner of the FLP was to be a newly
created LLC that would be initially funded with $300,000 and wholly owned by
Mrs. Williams. Mrs. Williams was diagnosed with cancer in March 2000. Following
months of drafting and revisions to the partnership agreement forming the FLP,
Mrs. Williams signed the agreement on May 9, 2000, and the documents to fund the
The schedule of capital accounts on the FLP agreement were intentionally left
blank in order to later determine the accurate market value of the assets used
to fund the entity. On May 10, 2000, the FLP’s agent applied for a tax
identification number for the entity, began the process for establishing a new
account to hold the FLP’s assets, and wrote a $300,000 check to fund the FLP’s
new LLC general partner. Mrs. Williams died on May 15, 2000, before signing the
Initially, all activity ceased on formalizing and funding the FLP after Mrs.
Williams’ death. Approximately twelve months later, one of the estate’s
executors heard about the decision in Church v. United States, 2000 U.S.
Dist. LEXIS 714 (W.D. Tex. 2000), and he believed that Mrs. Williams had
successfully formed and begun the process of funding the FLP prior to her death.
Moreover, the estate had paid estimated federal estate tax of $147 million, nine
months after the date of death. In Church, the formation of the FLP was
completed after the death of the donor, but the donor’s intent to create the FLP
was found to control the creation and funding of the FLP under Texas law. The
executors resumed their efforts to formally establish the FLP, and sought an
estate tax refund in excess of $40 million.
The court found that at the time of her death, Mrs. Williams intended certain
bonds to be FLP property. Likewise, the court determined that Mrs. Williams
intended that the LLC general partner of the FLP was to be capitalized with
$300,000. Under Texas law, the court found that the executors had a duty to
complete the transaction to form the LLC. The court concluded that the FLP was
fully formed and funded prior to Mrs. Williams’ death. The court heard testimony
from both the estate’s and Service’s valuation experts on the availability of
discounts for marketability and lack of control. The court found the estate’s
expert to be more credible, in part to due to errors in the Service’s expert’s
application of the willing buyer and seller standard, and accepted a 47.5%
The court stated that Texas law provides that the intent of an owner to
transfer assets to a partnership will cause assets to be considered partnership
property, regardless of whether title to the property has been transferred.
Therefore, the court found that Mrs. Williams was obligated to fund the LLC
general partner. Finding that Mrs. Williams intended to fund the FLP at the time
she signed the partnership agreement, the court determined that the FLP was a
valid Texas limited partnership before her death. Accordingly, since the assets
were considered FLP property before her death, the FLP interests were eligible
for a valuation discount, and the estate could claim an estate tax refund based
on the discounted value.
The court held that Mrs. Williams’ transfer met the definition of a “bona
fide sale” under sections 2036(a) and 2038(a), and was not otherwise a sham
transaction. There was a transfer for adequate consideration and a significant
non-tax reason for creating the partnership. The court found that the primary
purpose of creating the FLP was to protect the family’s assets from ex-spouses’
claims in divorce proceedings. Additionally, it was significant that Mrs.
Williams retained substantial assets outside of the FLP on which to live, and
upon liquidation of the FLP, each partner was to receive the value of his or her
capital account that corresponded to the interests in the FLP.
The court found that the estate had met its burden of proof and was entitled
to a refund of estate taxes which amounted to a nearly 50% valuation discount of
the FLP interests. This case required a four-day trial, and the judge took
almost two and one-half years to issue his opinion. The Service may appeal this
case to the Fifth Circuit in the hope of getting a more favorable result at the
Malkin v. Comm’r, T.C. Memo 2009-212 (Sept. 16,
The Service asserted deficiencies in excess of $11 million in federal gift
tax and $6 million in federal estate tax against the Estate of Rodger Malkin.
During his life, Mr. Malkin created two FLPs and four trusts to benefit his two
children. One FLP (MFLP) was funded with Mr. Malkin’s company stock, while the
other FLP (CRFLP) was funded with company stock and interests in four LLCs that
he owned with his son.
The court considered whether Mr. Malkin retained possession and enjoyment of
the stock transferred to the FLPs under section 2036(a), thereby causing the
value of the stock to be included in his gross estate. Additionally, the court
considered whether he made indirect lifetime gifts to his children of the FLPs’
underlying assets. The court also considered whether he made various other
direct and indirect gifts to his children during the last three years of his
In 1998, Mr. Malkin created two trusts, one to benefit each of his children.
Each trust was funded with cash. Following the registration of MFLP in
Mississippi on Aug. 31, 1998, Mr. Malkin funded it with nearly $17 million in
stock in one company called Delta & Pine Land of which Mr. Malkin was the CEO
and chairman for twenty years. The trustees of the children’s trusts entered
into contracts to purchase certain units of MFLP for each trust with a
combination of a cash down payment and a nine-year self-canceling installment
note. Over a year after MFLP was created and the trusts were funded, the
trustees of the children’s trusts authorized Mr. Malkin to pledge MFLP’s assets
in order to secure two of Mr. Malkin’s personal debt obligations. The collateral
used to secure each debt obligation was equal to nearly all of MFLP’s underlying
In May 1999, Mr. Malkin was diagnosed with pancreatic cancer. Several months
later he organized the second FLP, CRFLP. On Feb. 29, 2000, CRFLP was funded
with Mr. Malkin’s interests in four LLCs. The next day Mr. Malkin executed
documents to establish two additional trusts, one for each of his children, to
hold interests in CRFLP. The trustees of these trusts entered into contracts to
purchase interests in CRFLP through a combination of a cash down payment and a
nine-year promissory note. Additionally, in November 2000, Mr. Malkin funded
CRFLP with certain shares of stock that he had previously used as collateral for
another personal debt obligation. The stock remained collateral for the debt
following the transfer to CRFLP. The trustees never made interest payments on
the promissory notes to CRFLP before or after Mr. Malkin’s death on Nov. 22,
Prior to his death, from 1998-2000, Mr. Malkin also: (i) made direct
transfers of several hundred thousand dollars to his children; (ii) paid several
million dollars of the outstanding debts of the LLCs he co-owned with his son;
and (iii) assigned a $1 million promissory note to one of the LLCs.
In considering whether Mr. Malkin retained the use and enjoyment of the
property transferred to the FLPs, the Service asserted that both an express and
implied agreement existed between Mr. Malkin and the trustees of the children’s
trusts to permit him to retain the present economic benefits of the stock that
he used to fund the two FLPs. The executors of Mr. Malkin’s estate contended
that no agreement existed to permit Mr. Malkin to retain the economic benefits
of the property used to fund the FLPs. Additionally, the executors argued that
the trustees’ ratification of Mr. Malkin’s pledge of the FLP shares for his
personal debt obligations was an investment decision that was made at arm’s
length and was otherwise in the best interests of MFLP.
Although the court found that Mr. Malkin did not retain the economic benefit
of the LLC interests used to fund CRFLP, the court agreed with the
Service as to Mr. Malkin’s retained benefit and use of the stock used to fund
both FLPs. Citing section 20.2036-1(b)(2) of the Estate Tax Regulations, the
court stated that the retained use and enjoyment of transferred property
includes property used to discharge a legal obligation. Accordingly, the court
found that the stock Mr. Malkin used to fund the FLPs was applied toward
discharging his debt obligations.
The court further found insufficient evidence to support the executors’
argument that the trustees’ approval of Mr. Malkin’s pledge of the FLP’s
underlying assets was in fact a business decision made at arm’s length, or that
it was otherwise in the best interests of MFLP. Likewise, the court found no
business reason for CRFLP to hold shares pledged to secure Mr. Malkin’s personal
debt. The court determined that Mr. Malkin’s unrestricted use of the shares used
to fund the FLPs suggested an implied agreement that the shares were available
for his use and enjoyment. Therefore, Mr. Malkin retained the possession and
enjoyment of the shares within the meaning of section 2036(a)(1).
Because Mr. Malkin had retained the use and the enjoyment of the transferred
property, the court next considered whether his transfer of stock to the FLPs
fell within the section 2036(a) exception for “bona fide sales” for “adequate
and full consideration in money or money’s worth.” The court held that the
exception did not apply because Mr. Malkin had no legitimate and significant
non-tax reason for creating the FLPs. It specifically rejected the three non-tax
reasons offered by the estate: (i) providing for children by having the
appreciation pass to the children and not to the decedent; (ii) protecting the
Delta Pine & Land stock from a sale; and (iii) centralizing management of the
family’s wealth. Since Mr. Malkin’s transfers did not qualify for the bona fide
sales exception under section 2036(a), the value of the stock held by the FLPs
was includable in his gross estate.
The court next considered whether Mr. Malkin made indirect gifts to his
children when he funded CRFLP with his LLC interests, then made gifts of
interests in CRFLP to his children’s trusts. The court found that the transfers
were analogous to the transfers in Shepherd, finding that Mr. Malkin
created CRFLP, funded it with LLC interests, and then assigned CRFLP interests
to each child’s trust the next day. The court rejected the executors’ reliance
on the purported sale of CRFLP interests to the trusts, finding it to be a sham.
The court noted that Mr. Malkin was terminally ill at the time the trusts were
alleged to have purchased the interests from CRFLP.
Additionally, the court found that Mr. Malkin provided the cash for the down
payments, even though each child individually had millions of dollars of assets
to make the payments. The court found that the promissory notes were the only
consideration the trusts gave to Mr. Malkin, but that there was no evidence to
support the conclusion that either Mr. Malkin or his children expected the notes
would be paid. Holding that the purported sale by CRFLP to the trusts was a
sham, the court determined that Mr. Malkin made indirect gifts to his children
of his interests in the LLCs.
With respect to certain cash transfers Mr. Malkin made to his children from
1998-2000, the court found that the promissory notes which attempted to disguise
the direct gifts as loans were not assets of the gross estate. The court
determined that Mr. Malkin made direct cash gifts to his children, and that the
transfers should be reported on Mr. Malkin’s gift tax returns. The court further
concluded that Mr. Malkin made additional indirect gifts to his children when he
paid the debts of the LLCs used to fund the FLPs. He also made indirect gifts to
his children when he transferred cash and a promissory note to one of the LLCs.
Lastly, the court rejected a deduction claimed by the estate for non-recourse
debt of Mr. Malkin’s to the extent that the estate’s claimed deduction exceeded
the value of the property securing the debt. The court disallowed an additional
$2 million deduction the estate claimed as Mr. Malkin’s debt. With respect to
this debt, the court determined that Mr. Malkin did not have a contractual
obligation to purchase units in an LLC of which he was not a member at the time
of his death. The court further disallowed deductions for executors’
commissions, attorneys’ fees, and accounting fees as the executors presented no
evidence that the amounts were paid and that the estate was otherwise entitled
to claim the deductions.
In light of the court decisions above, individuals, trusts, and other
entities considering FLPs or LLCs should consider the following steps, among
- Identifying legitimate business and/or investment reasons for the FLP or
- If possible, including assets that require active management in the FLP
or LLC, such as real estate.
- Keeping sufficient assets outside of the FLP or LLC to provide for the
donor's support, so that he or she does not have to rely on FLP or LLC
- Administering an FLP or LLC in accordance with its terms, and not
treating the FLP or LLC as a personal checking account for the partners or
- Avoiding creating the FLP or LLC for an elderly individual who may die
- Having as long a period of time as possible between the contribution of
assets to an FLP or LLC and the subsequent gifts of those FLP or LLC
interests to family members or others.
- Avoiding status as a “disregarded entity” because there is a single
member of an LLC by transferring a small interest in the LLC initially to
family members or others to avoid having a court in the future apply the
disregarded entity regulations to the transfers of the LLC interests as the
Service asserted in Pierre.
The Service is continuing to aggressively challenge FLPs and LLCs, and only
those that are formed and operated correctly will survive the scrutiny of the
Service and the courts and provide the desired non-tax and tax benefits.
McGuireWoods Fiduciary Advisory Services
Services assists financial institutions in a wide array of areas in which
questions or concerns may arise. This includes advising corporate trustees on
how to avoid litigation before it arises, and how to address litigation when it
does arise. For further information on the recent cases cited above or
McGuireWoods Fiduciary Advisory Services, please contact the authors.