Welcome to TaxView with Chris Moss CPA

Are you an entrepreneur with family business? Have you thought about your children and grandchildren being more involved in your business? Perhaps a Family Limited Liability Company (Family LLC) is just what you need. Properly structured for your unique situation, the Family LLC is a 21st century way to hand down the family business for generations to come in a safe, protected and orderly business structure. But if you set up your Family LLC be aware you face dangerous IRS tax mines hidden in IRS Code Section 2036(a) that could explode your tax plan into an IRS audit focusing on when a gift is not a gift (GINAG) and when a transfer is not a transfer (TINAT). Indeed, you may experience unexpected increases in estate tax so high the children might have to sell the farm just to pay the tax. So if you don’t want GINAG or TINAT, or just want to learn more about them, stay with us here on TaxView with Chris Moss CPA to fully understand how to avoid GINAG, TINAT, and Section 2036(a) so you can save and preserve your assets for your children for many generations to come.

Section 2036(a) prohibits you transferring property out of your estate that are “testamentary “in nature. The US Supreme Court in Grace V US, 395 US 316 (1969) has defined “testamentary” as those transfers which leave you in significant control over the property transferred. For example you still control the business you just transferred to your children.Section 2036(a) does not apply to transfers that are bona-fide sales for adequate and full consideration. Furthermore, the bona fide sale exception is satisfied where the record establishes you had a legitimate and significant nontax reason for creating your Family LLC, and your children received membership interests proportionate to the value of the property transferred. Turner v IRS 2011 at page 33. Therefore, all transfers and gifts to adult or minor children in a Family Limited Liability Company must be perfectly executed to comply with Section 2036(a). See Bigelow v IRS, 503 F.3d 955 (2007)Affirming Bigelow v IRS T.C. Memo. 2005-65; also see Rector v IRS 2007.

Our first US Tax Court case is True v IRS 2001. Dave and Jean True made direct gifts in their family business to some or all of their children every year form 1955-1993 at the maximum annual exclusion each year. True did not use a Family LLC. Instead of using an LLC Operating Agreement, True created restrictive buy-sell agreements for all of the family. This Agreements gave Dave True total control over all family business. Dave True died on June 4, 1994 with many various trusts in place with True still maintaining control over all businesses. An Estate Tax return was filed on March 3, 1995 with the Estate valued less the value of all the gifts given to all the children over all the years. The estate was audited by the IRS in 1998. Do you all see the GINAG and TINAT coming?

Sure enough the IRS determined that the whole purposes of the gifts to the True children and related buy-sell agreements was to avoid estate tax. The Government sent the True family a bill for over $75 Million plus $30 Million in penalties adding back all those gifts as a violation of Section 2036(a). This is major GINAG. Why? True was giving everything away without a business structure to back up his estate plan making the primary motive to avoid estate tax. As the Court notes on page 108 of this over 300 page Opinion, Dave True had “control” over the whole operation which made for good GINAG in that he had a “life estate” in the business operations. In my view if True had set up a Family Limited Liability Company with normal restrictions placed in a family Operating Agreement allowing the family under unanimous consent provisions to control the assets, GINAG and TINAT would have been avoided, and assets would have been preserved and protected from Section 2036(a). Unfortunately for the True children, IRS wins True loses.

Our next case is Hurford v IRS 2008. Thelma Hurford was a very wealth widow. On advice of legal counsel she formed a Family Limited Partnership which allowed her to transfer assets, including farms and ranches into a single entity. Hurford gave a 25% interest to each of her children. But Hurford still maintained control over everything. GINAG is written all over this. Hurford even remained the sole signatory on many of the accounts. Hurford died on February 19, 2001. The estate tax return was filed on September 26, 2001. The IRS audited the return on November 18, 2004 claiming Hurford owed over $20 Million for estate and gift tax. Hurford appealed to US Tax Court in Hurford v IRS 2008.

Judge Holmes and the Government proposed GINAG for the whole estate plan calling it nothing more than a transparently thin substitute for a will. The Court agreed with the Government finding that Hurford retained an impermissible interest in the assets she had tried to transfer to her children in total violation of Section 2036(a). Further the Court noted that Thelma commingled her own funds with the partnerships until shortly before she died, and that there was no meaningful economic activity where the partnership furthers family investment goals or where the partners work together to jointly manage family investments. You guessed it IRS wins Hurford loses.

Our last case: Stone vs IRS 2003. Mr. and Mrs. Stone founded multiple business ventures. They were also beneficiaries of various trusts. Perhaps due to or because of all this wealth, the family and 4 children Eugene, Rivers, Rosalie and Mary and other parties sued each other in the early 1990s over these trusts. After settlement of all the litigation, Stone formed 5 family limited partnerships in 1996 for his wife and 4 adult children. The partnership agreements provided unanimous consent of all partners to sell, transfer or encumber property and the children worked in the businesses owned by the partnerships. Mr. Stone died as a South Carolina resident on June 5, 1997 at age 89. Mrs. Stone died on October 16, 1998 at age 86. An estate tax return was filed for both Mr. and Mrs. Stone and the IRS eventually audited. The Government sent Mr. Stone a bill for $8 Million and Mrs. Stone a bill for $1.5 Million claiming the transfers to the partnerships violated Section 2036(a). Stones appealed to US Tax Court Stone v IRS 2003.

Judge Chiechi notes that the Stones retained enough assets in their estate to maintain their life style. The Court found that transfers were motivated primarily by investment and business concerns relating to the management of certain of the respective assets of Mr. and Mrs. Stone during their lives and thereafter. The Court concludes that the partnerships had economic substance and operated as joint enterprises for profit through which the children actively participated in the management and development of the assets and therefore the transfers were bona fide sales for adequate and full consideration in money or money’s worth under section 2036(a). Stone wins IRS Loses. Also see Mirowski v IRS US Tax Court 2008

So what does this all mean for us? If you have a business or perhaps multiple businesses and your tax attorney has suggested a Family Limited Liability Company which will own all of these businesses make sure the operating agreements protect you from Section 2036(a) and GINAG and TINAT. Based on the US Tax Court case law, retain some assets for yourself to maintain your lifestyle and perhaps transfer everything else to the LLC. Regarding adult children who are willing to participate in the family business see to it that they are signatures on the bank accounts and make sure there are unanimous consent requirements for all important decisions. Any gifts to minor children through the annual tax free gift exclusion require an absolute legitimate bullet proof non tax purpose in forming the LLC. Finally consult a tax attorney to create your unique business plan. Avoid GINAG and TINA. Most importantly avoid violation of Section 2036(a). You will be ready for any IRS audit coming your way and your assets will be part of your family legacy to your children and your children’s children for many years to come.

Thanks for joining me on TaxView with Chris Moss CPA.

Kindest regards
Chris Moss CPA

Welcome to TaxView, with Chris Moss CPA

Death tax is a fact of life, or death, as the case may be, and  Governments have been taxing us for thousands of years with death taxes when we die. 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.

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 tax attorney Chris Moss CPA.

Kindest regards and see you next time,
Chris Moss CPA