118 T.C. No. 14
UNITED STATES TAX COURT
CHRISTINE M. HACKL, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ALBERT J. HACKL, SR., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 6921-00, 6922-00. Filed March 27, 2002.
In 1995 and 1996, Ps A and C made gifts to their children and grandchildren of membership units in Treeco, LLC, a limited liability company. Treeco had previously been organized by A to hold and operate tree farming properties. This timberland had been purchased by A to provide investment diversification in the form of long-term growth and future income. Treeco was governed by an Operating Agreement which set forth the rights and duties conferred on members and the manager and which designated A as manager. At the time of the gifts, it was correctly anticipated that Treeco and its successor entities would generate losses and make no distributions for a number of years.
Held: The gifts of Treeco units made by Ps fail to qualify for the annual gift tax exclusion provided in sec. 2503(b), I.R.C. - 2 -
Barton T. Sprunger and Mark J. Richards, for petitioners.
Russell D. Pinkerton, for respondent.
OPINION
NIMS, Judge: By separate statutory notices, respondent
determined a deficiency in the 1996 Federal gift tax liability of
petitioner Christine M. Hackl (Christine Hackl) in the amount of
$309,866 and in the 1996 Federal gift tax liability of Albert J.
Hackl, Sr. (A.J. Hackl), in the amount of $309,950. Petitioners
each timely filed for redetermination by this Court, and, due to
an identity of issues, the cases were consolidated for purposes
of trial, briefing, and opinion. In accordance with stipulations
of partial settlement filed by the parties, the sole matter
remaining for decision is whether gifts made by petitioners of
units in a limited liability company qualify for the annual
exclusion provided by section 2503(b).
Unless otherwise indicated, all section references are to
sections of the Internal Revenue Code in effect for the year at
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
Background
These cases were submitted fully stipulated pursuant to Rule
122, and the facts stipulated are so found (except as noted in
footnote 1). The stipulations of the parties, with accompanying - 3 -
exhibits, are incorporated herein by this reference. At the time
their respective petitions were filed, petitioners resided in
Indianapolis, Indiana.
Personal, Educational, and Occupational Background
Petitioners are husband and wife and are the parents of
eight children. As of the date of the gifts at issue, they were
also the grandparents of 25 minor grandchildren.
A.J. Hackl was born on December 29, 1925, and Christine
Hackl was born on June 16, 1927. Since obtaining a Bachelor of
Mechanical Engineering degree from Georgia Institute of
Technology in 1946, A.J. Hackl has pursued a successful career in
business. He was employed by The Trane Company from 1946 to
1959, during which time he became a licensed professional
engineer and worked in several management positions. He next
accepted employment with Worthington Corporation, serving in
management and executive capacities within the company’s air
conditioning division from 1959 to 1968. Then, from 1968 until
his retirement in 1995, A.J. Hackl served as chief executive
officer of Herff Jones, Inc. During that period, Herff Jones
grew from a small, publicly held manufacturer of scholastic
recognition and motivational awards, with $18 million in annual
sales, to a national company with a broad line of products and
annual sales of $265 million. At the time of his retirement in
1995, A.J. Hackl owned a significant amount of Herff Jones stock, - 4 -
which he sold to the company’s employee stock ownership plan. He
then remained as chairman of the board of directors until 1998.
Initiation of Tree Farm Investment
In the mid-1990s, in anticipation of the sale of his Herff
Jones stock, A.J. Hackl began to research ways to diversify his
financial net worth into investments other than publicly traded
U.S. marketable securities, of which he had already accumulated a
substantial portfolio. He concluded that an investment in real
estate would achieve his objective of diversification and, after
consideration of a wide range of real estate ventures, decided
that tree farming presented an attractive business opportunity
which would both include the acquisition of significant parcels
of real estate and also fulfill his interest of remaining
personally active in business.
Since his other investments were generating a considerable
amount of current income, A.J. Hackl’s investment goal with
respect to his tree farming business was long-term growth. He
therefore chose to purchase land for use in the tree farming
business with little or no existing merchantable timber because
such land was significantly cheaper, and would provide a greater
long-term return on investment, than land with a substantial
quantity of merchantable timber.
In 1995, A.J. Hackl purchased two tree farms: (1) A 3,813.8
acre tract in Putnam County, Florida (Putnam County Farm) and (2) - 5 -
a 7,771.88 acre tract in McIntosh County, Georgia (McIntosh
County Farm). The Putnam County Farm was purchased on January 6,
1995, for $1,945,038, and contained merchantable timber valued at
$140,451 as of the time of purchase. The McIntosh County Farm
was purchased on June 23, 1995, and contained no merchantable
timber as of that date.
Formation of Treeco, LLC, and Gifting of Interests Therein
A.J. Hackl determined that the tree farming operations
should be conducted by a separate business entity (1) to shield
his assets not related to the tree farming business from
potential liability associated with that business, (2) to create
a separate enterprise in which family members could participate,
and (3) to facilitate the transfer of ownership interests in the
tree farming business to his children, their spouses, and his
grandchildren. Accordingly, A.J. Hackl executed Articles of
Organization creating Treeco, LLC, and on October 6, 1995, such
articles were filed with the Office of the Indiana Secretary of
State. As a result, Treeco was duly and validly organized as a
limited liability company (LLC) under the Indiana Business
Flexibility Act. The LLC format was selected by A.J. Hackl to
obtain liability protection for members, to provide protection of
assets inside the LLC from members’ creditors, to provide pass-
through income tax treatment, and to provide for centralized
management for the operation of the family tree farming business. - 6 -
On December 7, 1995, A.J. Hackl contributed the Putnam and
McIntosh County Farms to Treeco. Thereafter, on December 11,
1995, petitioners each recorded a capital contribution to Treeco
of $500 in exchange for 50,000 voting and 450,000 nonvoting units
in the LLC, thereby becoming the initial members of the entity
and each holding 50-percent ownership. They also on that date,
in their capacities as initial members, executed an Operating
Agreement to govern the Treeco enterprise.
The Operating Agreement provided that “Management of the
Company’s business shall be exclusively vested in a Manager” and
specified that such manager “shall perform the Manager’s duties
as the Manager in good faith, in a manner the Manager reasonably
believes to be in the best interests of the Company, and with
such care as an ordinarily prudent person in a like position
would use under similar circumstances.” The document designated
A.J. Hackl as the initial manager to serve for life, or until
resignation, removal, or incapacity, and also conferred on him
the authority to name a successor manager during his lifetime or
by will.
As regards distributions, the Agreement stated that the
manager “may direct that the Available Cash, if any, be
distributed to the Members, pro rata in accordance with their
respective Percentage Interests.” Available cash was defined as
cash funds on hand after payment of or provision for all - 7 -
operating expenses, all outstanding and unpaid current
obligations, and a working capital reserve. In addition, the
Agreement provided that, prior to dissolution, “no Member shall
have the right to withdraw the Member’s Capital Contribution or
to demand and receive property of the Company or any distribution
in return for the Member’s Capital Contribution, except as may be
approved by the Manager.” Members also in the Agreement waived
the right to have any company property partitioned.
Concerning changes in members and disposition of membership
interests, the Operating Agreement set forth specific terms with
respect both to withdrawal of members and transfer of membership
interests. Members could not withdraw from Treeco without the
prior consent of the manager. However, under the Agreement “A
Member desiring to withdraw may offer his Units for sale to the
Company, in the person of the Manager, who shall have exclusive
authority on behalf of the Company to accept or reject the offer,
and to negotiate terms.” Pertaining to transfer of interests,
the document recited as follows:
No Member shall be entitled to transfer, assign, convey, sell, encumber or in any way alienate all or any part of the Member’s Interest except with the prior written consent of the Manager, which consent may be given or withheld, conditioned or delayed as the Manager may determine in the Manager’s sole discretion.
If a transfer was permitted in accordance with this provision,
the transferee would have the right to be admitted as a
substitute member. If a transfer was made in violation of the - 8 -
foregoing procedure, the transferee would be afforded no
opportunity to participate in the business affairs of the entity
or to become a member; rather, he or she would only be entitled
to receive the share of profits or distributions which otherwise
would have inured to the transferor.
Among the rights afforded to members by the Operating
Agreement were the following: (1) Voting members had the right
to remove the manager and elect a successor by majority vote; (2)
voting members had the right to amend the Operating Agreement by
an 80-percent majority vote; (3) voting and nonvoting members had
the right to access the books and records of the company; (4)
voting and nonvoting members had the right jointly to decide
whether the company would be continued following an event of
dissolution; and (5) after the tenure of A.J. Hackl as manager,
voting members could dissolve the company by an 80-percent
majority vote.
As set forth in the Operating Agreement, Treeco was to be
dissolved upon the first to occur of four enumerated
circumstances:
(i) While A.J. Hackl is the Manager, by his written determination that the Company should be dissolved;
(ii) Following the tenure of A.J. Hackl as Manager by a written determination by Voting Members owning not less than eighty percent (80%) of the Voting Units of the Company that the Company should be dissolved; - 9 -
(iii) The occurrence of a Dissolution Event [defined as “the resignation, expulsion, bankruptcy, death, insanity, retirement, or dissolution of the Manager”] if the Company is not continued * * * [by a majority vote of the members within 90 days of the event]; or
(iv) At such earlier time as may be provided by applicable law.
Upon dissolution, distributions in liquidation were to be made
first to creditors, then to repay member loans, and finally to
members with positive capital account balances in proportion
thereto.
Subsequent to completion of the foregoing formalities,
petitioners on December 22, 1995, made further contributions to
Treeco. On that date petitioners contributed cash in the amount
of $5,000,000 and publicly traded securities valued at
$2,918,956. The cash and securities were held by Treeco to serve
as working capital and to finance additional purchases of tree
farm property.
Then, on December 29, 1995, petitioners commenced a program
of gifting interests in Treeco to family members. Petitioners
transferred 500 voting and 700 nonvoting units in Treeco to each
of their eight children and to the spouse of each such child. At
that time, each donee executed an acceptance of the Treeco
Operating Agreement. Petitioners reported the 1995 gifts of
Treeco units on timely filed gift tax returns and elected on
those returns to treat the gifts as made one-half by each of the - 10 -
petitioners pursuant to section 2513. Petitioners also treated
the gifts as qualifying for the annual exclusion of section
2053(b). Respondent did not issue notices of deficiency to
petitioners for 1995.
On January 18, 1996, Treeco purchased a third property in
Flager County, Florida (Flager County Farm), using $5,750,436 of
the LLC’s cash and securities. The Flager County Farm consisted
of 8,382 acres and contained merchantable timber valued at
$23,638 at the time of sale.
Thereafter, on March 5, 1996, petitioners continued their
program of gifting Treeco units with the gifts that are at issue
in this litigation. Petitioners once again each gave 500 voting
and 750 nonvoting units in Treeco to each of their eight children
and to the spouses of such children. Also on that date, A.J.
Hackl created the Albert James Hackl Irrevocable Trust
(Grandchildren’s Trust), for the benefit of petitioners’ minor
grandchildren. At that time, petitioners each transferred 31,250
nonvoting units in Treeco to the Grandchildren’s Trust,
representing 1,250 units for each of their 25 minor
grandchildren. Three of petitioners’ children were named as
trustees of the Grandchildren’s Trust and in that capacity
executed an acceptance of the Treeco Operating Agreement.
Petitioners reported the gifts made in 1996 on timely filed gift
tax returns and elected on those returns to treat the gifts as - 11 -
made one-half by each of them pursuant to section 2513. As
previously, annual exclusions were claimed under section 2503(b)
with respect to the gifts. Respondent disallowed the exclusions
by separate notices of deficiency dated April 14, 2000.
Operations of Treeco, LLC, and Successor Entities
On December 19, 1996, A.J. Hackl organized Hacklco, LLC, a
Georgia limited liability company, and in 1997, Treeco was
dissolved and merged into Hacklco, LLC. Similarly, on May 20,
1997, Treesource, LLLP, a Georgia limited liability limited
partnership, was organized, and Hacklco was merged into this
entity in 1998. These changes appear to have wrought no
alteration in the nature and operation of the Treeco enterprise
and, while enumerated for clarity, do not affect our analysis of
the gifted units. Petitioners continued making gifts of voting
and nonvoting units of Treeco’s successors in interest in 1997
and 1998, resulting in petitioners’ children and their spouses
owning, at all times subsequent to January 2, 1998, 51 percent of
the voting power of Treesource.
Treeco and its successors have at all times actively engaged
in tree farming. Since operations commenced in 1995, Treeco and
its successors have planted approximately 8 to 10 million trees
on their lands. A.J. Hackl, as manager of Treeco and its
successors, devotes approximately 750 to 1000 hours per year to
the farming operations. In addition, Georgia Pacific Corporation - 12 -
and F & W Forestry Services, Inc., were retained by Treeco to
provide consulting and management services for the tree farms.
Contained in the record are a Five-Year Timber Operating Budget
for the McIntosh County Farm, prepared by F & W Forestry
Services, and detailed forest management plans for the Putnam and
Flager County Farms, prepared by Georgia Pacific. These
documents discuss, among other things, plantation thinning,
reforestation, fertilization, and capital improvements. The F &
W Forestry Services budget projects losses through 2000 but
characterizes the McIntosh tract as having “great future income
potential”. The Georgia Pacific plan describing the Putnam
property similarly states: “These recommendations, if followed,
will provide you with a healthy, fast growing forest which will
lead to a steady stream of income in the future.” A.J. Hackl
meets on a regular basis with consultants from Georgia Pacific
and F & W Forestry Services regarding maintenance of the tree
farms. The parties have stipulated that he has always managed
Treeco and its successors with such care as an ordinarily prudent
person in a like position would use under similar circumstances.
The primary business purpose of all three of the above
entities has been to acquire and manage plantation pine forests
for long-term income and appreciation for petitioners and their
heirs and not to produce immediate income. Petitioners
anticipated that all three entities would operate at a loss for a - 13 -
number of years, and therefore, they did not expect that these
entities would be making distributions to members during such
years. Treeco reported losses in the amounts of $42,912,
$121,350, and $23,663 during 1995, 1996, and 1997, respectively.
Hacklco reported losses of $52,292 during 1997. Treesource
reported losses in the amounts of $75,179, $153,643, and $95,1561
in 1997, 1998, and 1999, respectively. Neither Treeco nor its
successors had at any time through April 5, 2001, generated net
profits or made distributions of cash or other property to
members.
Discussion
I. Settled and Disputed Issues
The parties have previously filed a Stipulation of Partial
Settlement, and a Supplemental Stipulation of Partial Settlement,
in which they agreed that the fair market value of both the
voting and nonvoting units of Treeco, LLC, was $10.43 per unit on
the date of the 1996 gifts at issue in these cases. Accordingly,
the sole issue for determination by the Court is whether
petitioners’ gifts of units in Treeco qualify for the annual
exclusion provided by section 2503(b), a dispute which turns on
1 Although the parties stipulated that Treesource reported a loss of $99,156 for 1999, Treesource’s 1999 return in fact reflects a loss of $95,156. See Cal-Maine Foods, Inc. v. Commissioner, 93 T.C. 181, 195 (1989) (holding that stipulations are properly disregarded where clearly contrary to evidence contained in the record). - 14 -
whether the transfers constitute gifts of a present interest for
purposes of the statute. In this connection, the parties have
also stipulated that the Grandchildren’s Trust satisfies the
requirements of section 2503(c) such that the annual exclusion
will be applicable for gifts thereto provided that the gifts are
otherwise determined to be of a present interest.
Additionally, to further clarify the issues, the parties
have stipulated that if the aforesaid question is decided in
petitioners’ favor, then in computing gift tax liability for
1996, the amounts of prior period taxable gifts reported on
petitioners’ 1996 returns shall be accepted as filed.
Conversely, if the above question is decided in favor of
respondent, the amounts of prior period taxable gifts reported on
petitioners’ 1996 returns shall be increased to reflect the
annual exclusions claimed by petitioners for gifts of Treeco
units in 1995.
II. Statutory and Regulatory Law
Section 2501 imposes a tax for each calendar year “on the
transfer of property by gift” by any taxpayer, and section
2511(a) further clarifies that such tax “shall apply whether the
transfer is in trust or otherwise, whether the gift is direct or
indirect, and whether the property is real or personal, tangible
or intangible”. The tax is computed based upon the statutorily
defined “taxable gifts”, which term is explicated in section - 15 -
2503. Section 2503(a) provides generally that taxable gifts
means the total amount of gifts made during the calendar year,
less specified deductions. Section 2503(b), however, excludes
from taxable gifts the first $10,000 “of gifts (other than gifts
of future interests in property) made to any person by the donor
during the calendar year”. In other words, the donor is entitled
to an annual exclusion of $10,000 per donee for present interest
gifts.
Regulations promulgated under section 2503 further elucidate
this concept of present versus future interest gifts, as follows:
Future interests in property.--(a) No part of the value of a 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, and whether or not supported by a particular interest or estate, which are limited to commence in use, possession, or enjoyment at some future date or time. The term has no reference to such contractual rights as exist in a bond, note (though bearing no interest until maturity), or in a policy of life insurance, the obligations of which are to be discharged by payments in the future. But a future interest or interests in such contractual obligations may be created by the limitations contained in a trust or other instrument of transfer used in effecting a gift.
(b) An unrestricted right to the immediate use, possession, or enjoyment of property or the income from property (such as a life estate or term certain) is a present interest in property. * * * [Sec. 25.2503-3, Gift Tax Regs.] - 16 -
III. Caselaw Development
The foregoing statutory and regulatory pronouncements have
been the subject of repeated interpretation by the Federal
courts. Much of the litigation has occurred in the factual
context of gifts in trust, including a series of seminal
decisions by the Supreme Court in the 1940s. Commissioner v.
Disston, 325 U.S. 442 (1945); Fondren v. Commissioner, 324 U.S.
18 (1945); Ryerson v. United States, 312 U.S. 405 (1941); United
States v. Pelzer, 312 U.S. 399 (1941); Helvering v. Hutchings,
312 U.S. 393 (1941); see also Calder v. Commissioner, 85 T.C. 713
(1985); Blasdel v. Commissioner, 58 T.C. 1014 (1972), affd. 478
F.2d 226 (5th Cir. 1973). Additionally, parallel to the
developments in the trust area and incorporating many of the same
principles, a line of cases has addressed the related situation
where transfers of property are made to an entity with
preexisting interest-holders. See, e.g., Stinson Estate v.
United States, 214 F.3d 846 (7th Cir. 2000); Chanin v. United
States, 183 Ct. Cl. 840, 393 F.2d 972 (1968).
In both scenarios, the gift in question takes the form of an
indirect gift of the underlying property to the beneficiaries of
the trust or to those holding interests in the entity. Helvering - 17 -
v. Hutchings, supra at 398; Chanin v. United States, supra at
975; Blasdel v. Commissioner, supra at 1022. Furthermore, it has
become well settled that to qualify as a present interest, such a
gift must confer on the donee not just vested rights but a
substantial present economic benefit by reason of use,
possession, or enjoyment of either the property itself or income
from the property. Fondren v. Commissioner, supra at 20-21;
Estate of Holland v. Commissioner, T.C. Memo. 1997-302.
The cases have also established through oft-repeated
directives that where the use, possession, or enjoyment is
postponed to the happening of a contingent or uncertain future
event, such as where distributions of property or income will
occur only at the discretion of a trustee or upon joint action of
entity interest holders, or where there is otherwise no showing
from facts and circumstances of a steady flow of funds from the
trust or entity, the gift will fail to qualify for the section
2503(b) exclusion. Commissioner v. Disston, supra at 449;
Ryerson v. United States, supra at 406-408; United States v.
Pelzer, supra at 403-404; Chanin v. United States, supra at 976;
Calder v. Commissioner, supra at 727-730. - 18 -
The taxpayer bears the burden of showing that the gift at
issue is other than of a future interest.2 Rule 142(a);
Commissioner v. Disston, supra at 449; Stinson Estate v. United
States, supra at 848.
IV. Contentions of the Parties
Against the foregoing background, we turn to the contentions
of the parties before us. Petitioners contend their transfers of
units in Treeco are properly characterized as present interest
gifts. Petitioners emphasize that they made direct, outright
transfers of the Treeco units, which are personal property
separate and distinct under Indiana law from Treeco’s assets.
Petitioners further maintain that the units had a substantial and
stipulated value; that petitioners’ transfers placed no
restrictions on the donees’ interests in the units; and that the
donees upon transfer acquired all rights in and to the gifted
units, which rights were identical to those petitioners had in
the units they retained. Hence, according to petitioners, their
transfers involved no postponement of rights, powers, or
privileges that would cause the gifts to constitute future
interests.
2 Cf. sec. 7491, which is effective for court proceedings that arise in connection with examinations commencing after July 22, 1998, and which can operate to place the burden on the Commissioner in enumerated circumstances. Petitioners here have not contended, nor is there evidence, that their examinations commenced after July 22, 1998, or that sec. 7491 applies in these cases. - 19 -
Petitioners also argue that the cases involving indirect
transfers through trusts and corporations are inapplicable to the
direct transfers at issue here. Petitioners allege:
When an equity interest in a business (or any property) is transferred outright, the donee receives all rights in and to the equity interest (or other property) upon transfer, whatever those rights may be. The lack of any “postponement” of the donee’s rights to enjoyment of the equity interest (or other property) is manifestly clear. * * *
From the foregoing premise, petitioners maintain that the
standards referenced to analyze whether rights are postponed when
interests in the subject property are held only indirectly
through the conduit of a trust or corporate entity have no place
in the present situation.
Conversely, respondent argues that petitioners’ transfers of
Treeco units fail to qualify as gifts of present interests.
Respondent avers that because of the restrictions contained in
the Treeco Operating Agreement, the transfers fell short of
conferring on the donees the requisite immediate and
unconditional rights to the use, possession, or enjoyment of
property or the income from property. Unlike petitioners,
respondent finds the body of law regarding indirect transfers to
constitute “substantial analogous authority” and the principles
espoused therein to control the outcome of these cases.
Specifically, respondent emphasizes the requirement of present
economic benefit and contends that the inability of the donees to - 20 -
freely transfer the units or to compel distributions from the
entity prevented them from receiving any such benefit on account
of the transfers. Thus, in respondent’s view, the gifts
postponed any economic benefit and therefore were of future
V. Analysis
A. Applicable Standards
As framed by the parties’ contentions, a threshold issue we
must address is the extent to which the standards expressed in
the decided cases interpreting section 2503(b) are pertinent
here. As petitioners correctly note, the property with which we
are concerned in this matter is an ownership interest in an
entity itself, rather than an indirect gift in property
contributed to the entity. Treeco was duly organized and
operating as an LLC, units of which under Indiana law are
personal property separate and distinct from the LLC’s assets.
See Ind. Code Ann. secs. 23-18-1-10, 23-18-6-2 (West 1994).
Nonetheless, while State law defines property rights, it is
Federal law which determines the appropriate tax treatment of
those rights. United States v. Natl. Bank of Commerce, 472 U.S.
713, 722 (1985); Knight v. Commissioner, 115 T.C. 506, 513
(2000). It thus is Federal law which controls whether the
property rights granted to the donees as LLC owners under State - 21 -
law were sufficient to render the gifts of present interests
within the meaning of section 2503(b). See United States v.
Pelzer, 312 U.S. at 402-403.
Moreover, we conclude that the relevant body of Federal
authority encompasses the general interpretive principles
developed through the extensive litigation involving indirect
gifts. To disregard longstanding directives that a present
interest gift exists only where a donee receives noncontingent,
independently exercisable rights of substantial economic benefit
cannot be justified in the face of either the language used by
the Supreme Court or the subsequent application of such language.
See Fondren v. Commissioner, 324 U.S. at 20-21; Ryerson v. United
States, 312 U.S. at 408; United States v. Pelzer, supra at 403-
404.
For example, in Fondren v. Commissioner, supra at 20-21, the
Court explains the meaning of future versus present interest in
general terms, stating:
it is not enough to bring the exclusion into force that the donee has vested rights. In addition he must have the right presently to use, possess or enjoy the property. These terms are not words of art, like “fee” in the law of seizin * * *, but connote the right to substantial present economic benefit. The question is of time, not when title vests, but when enjoyment begins. Whatever puts the barrier of a substantial period between the will of the beneficiary or donee now to enjoy what has been given him and that enjoyment makes the gift one of a future interest within the meaning of the regulation. - 22 -
The Court thus says that the terms “use, possess or enjoy”
connote the right to substantial present economic benefit. This
phraseology is broad and is in no way limited to the factual
context presented. It defines the root words of the regulatory
standard which no party disputes is a generally applicable and
valid interpretation of section 2503(b). See sec. 25.2503-3,
Gift Tax Regs. We therefore would be hard pressed to construe
“use, possession, or enjoyment” as meaning something different or
less than substantial present economic benefit simply because of
a shift in the factual scenario or form of gift to which the test
is being applied. Accordingly, we are satisfied that section
2503(b), regardless of whether a gift is direct or indirect, is
concerned with and requires meaningful economic, rather than
merely paper, rights.
Furthermore, this idea is buttressed by recognition that in
an earlier case we quoted the very language from Fondren v.
Commissioner, supra, set forth above in a context that involved
outright gifts. In Estate of Holland v. Commissioner, T.C. Memo.
1997-302, we quoted the Fondren text en route to concluding that
outright gifts in the form of $10,000 checks, which had been
properly endorsed and deposited, were gifts of a present
interest.
In a similar vein, previous caselaw from this Court reveals
that the principles established in United States v. Pelzer, supra - 23 -
at 403-404, and Ryerson v. United States, supra at 408, regarding
contingency and joint action are not restricted in their
applicability to indirect gift situations. In Skouras v.
Commissioner, 14 T.C. 523, 524-525 (1950), affd. 188 F.2d 831 (2d
Cir. 1951), the taxpayer assigned outright all incidents of
ownership in several insurance policies on his life to his five
children jointly and continued to pay the premiums thereon.
Given these facts, we, citing United States v. Pelzer, supra,
stated broadly that “where the use, possession, or enjoyment of
the donee is postponed to the happening of future uncertain
events the interest of the donee is a future interest within the
meaning of the statute.” Id. at 533. Then, relying on Ryerson
v. United States, supra, and in spite of the taxpayer’s argument
that “there was not a grant to trust as in the Ryerson case”, we
ruled that the taxpayer, by “making the assignments to his five
children jointly, had postponed the possession and enjoyment of
the rights and interests in and to the policies or the proceeds
thereof until his death or until such time as the children,
acting jointly, might change or negative the action he had thus
taken.” Id. at 534.
In sum, we reject petitioners’ contention that when a gift
takes the form of an outright transfer of an equity interest in a
business or property, “No further analysis is needed or
justified.” To do so would be to sanction exclusions for gifts - 24 -
based purely on conveyancing form without probing whether the
donees in fact received rights differing in any meaningful way
from those that would have flowed from a traditional trust
arrangement.
Petitioners’ advocated approach could also lead to
situations where gift tax consequences turned entirely upon
distinctions in the ordering of transactions, rather than in
their substance. For example, while petitioners contributed
property to an LLC and then gifted ownership units to their
children and grandchildren, a similar result could have been
achieved by first transferring ownership units and then making
contributions to the entity. Yet petitioners would apparently
have us decide that the latter scenario falls within the rubric
of established precedent while the former is independent thereof.
We decline to take such an artificial view.
We are equally unconvinced by petitioners’ attempts to avoid
the principles discussed above with the assertion that
the postponement question deals with rights to present use, possession or enjoyment of the transferred property, not the likelihood of the actual use, possession, or enjoyment of the property. See, Estate of Cristofani v. Comm’r, 97 T.C. 74 (1991); Crummey v. Comm’r, 397 F.2d 82 (9th Cir. 1968); Kieckhefer v. Comm’r, 189 F.2d 118 (7th Cir. 1951); Gilmore v. Comm’r, 213 F.2d 520, 522 (6th Cir. 1954) * * *
Each of the above-cited cases involved trusts in which
beneficiaries were given an absolute right to demand
distributions and have not been interpreted to establish a rule - 25 -
inconsistent with those enunciated by the Supreme Court. See
Rassas v. Commissioner, 196 F.2d 611, 613 (7th Cir. 1952)
(distinguishing Kieckhefer v. Commissioner, supra), affg. 17 T.C.
160 (1951). Thus, instead of adopting an approach which would
undermine the purpose and integrity of the section 2503(b)
exclusion, we for the reasons explained above conclude that
petitioners are not by virtue of making outright gifts relieved
of showing that such gifts in actuality involved rights
consistent with the standards for a present interest set forth in
regulations and existing caselaw.
To recapitulate then, the referenced authorities require a
taxpayer claiming an annual exclusion to establish that the
transfer in dispute conferred on the donee an unrestricted and
noncontingent right to the immediate use, possession, or
enjoyment (1) of property or (2) of income from property, both of
which alternatives in turn demand that such immediate use,
possession, or enjoyment be of a nature that substantial economic
benefit is derived therefrom. In other words, petitioners must
prove from all the facts and circumstances that in receiving the
Treeco units, the donees thereby obtained use, possession, or
enjoyment of the units or income from the units within the above-
described meaning of section 2503(b). - 26 -
B. Application to the Gifted Property
Beginning with the property itself, we reiterate that the
donees in these cases did receive, at least in the sense of
title, outright possession of the Treeco units. Nonetheless, as
previously explained, the simple expedient of paper title does
not in and of itself create a present interest for purposes of
section 2503(b) unless all the facts and circumstances establish
that such possession renders an economic benefit presently
reachable by the donees. It therefore is incumbent upon
petitioners to show the present (not postponed) economic benefit
imparted to the donees as a consequence of their receipt of the
Treeco units.
In considering this issue, we first address the role of the
Treeco Operating Agreement in our analysis. Petitioners state
that each gifted Treeco unit “represented a significant bundle of
legal rights in the venture, rights which are defined by the
Operating Agreement, Treeco’s Articles of Organization, and
Indiana statutory and common law”. At the same time, petitioners
aver: “The postponement question is not concerned with
contractual rights inherent in the transferred property, but
rather in whether, in the transfer of the property, the
transferor imposed limitations or restrictions on the present
enjoyment of the property.” They then go on to quote the
language from section 25.2503-3(a), Gift Tax Regs., which - 27 -
references contractual rights in a bond, note, or insurance
policy that do not result in a future interest characterization.
Hence, while petitioners seem to acknowledge that the Operating
Agreement in large part defines the nature of the property
received by the donees, they also apparently would have us ignore
any provisions of the Agreement which limited the ability of the
donees to presently recognize economic value as akin to the
contractual rights mentioned in the regulation.
However, petitioners’ reliance on section 25.2503-3(a), Gift
Tax Regs., is misplaced. This Court has previously taken a much
narrower view of the cited regulatory language. In Estate of
Vose v. Commissioner, T.C. Memo. 1959-175, vacated and remanded
on another issue 284 F.2d 65 (1st Cir. 1960), we opined that the
regulations were “designed to cover notes and bonds which,
although perhaps not containing all of the attributes of
negotiable instruments, are at least definitely enforceable legal
obligations payable on a day certain and immediately disposable
by the obligee.” LLC units hardly fall within these parameters,
and we observe that the quoted reasoning is consistent with our
focus on requiring some presently reachable economic benefit.
Furthermore, petitioners’ attempts to find in these
regulations support for a distinction between limitations
contractually inherent in the transferred property and
restrictions imposed upon transfer are not well taken. All facts - 28 -
and circumstances must be examined to determine whether a gift is
of a present interest within the meaning of section 2503(b), and
this will be true only where all involved rights and
restrictions, wherever contained, reveal a presently reachable
economic benefit. Since here the primary source of such rights
and restrictions is the Treeco Operating Agreement, its
provisions, in their cumulative entirety, must largely dictate
whether the units at issue conferred the requisite benefit.
Accordingly, we now turn to the Operating Agreement to flesh out
the nature of the property rights transferred to the donees at
the time of their receipt of the Treeco units and whether such
rights rose to the level of a present interest on account of
either the units themselves (considered in this section) or the
income therefrom (considered in section IV.C., infra).
Petitioners offer the following summary of the rights
inuring to the donees upon their receipt of the LLC units:
Upon transfer the Donees acquired membership rights and obligations in the gifted Treeco units which were identical to those which Petitioners had in the Treeco units they retained, including the rights under the Treeco Operating Agreement to have all net income or capital gains allocated, all cash distributions made, and net loss allocated (subject to an allocation of losses to A.J. Hackl for a period which was designed to ensure the current deductibility of Treeco losses for federal income tax purposes) based on the number of units held in relation to the total number of units, the right to have capital accounts established and maintained on behalf of each member in the manner provided by Treas. Reg. § 1.704-1(b)(2)(iv), the right to offer units for sale to Treeco, or to sell their units to third parties (subject to manager approval), - 29 -
the rights (voting members) to remove the manager, amend Treeco’s organizational documents, dissolve Treeco, approve salaries or bonuses paid to any manager, etc., all of which rights are entitled to court enforcement. * * *
At the outset, we note that petitioners’ repeated assertions
that the rights conferred on the donees were identical to those
retained by the donors have little bearing on our analysis. A
similar fact did not dissuade us from finding only a future
interest in Blasdel v. Commissioner, 58 T.C. 1014 (1972), and we
are satisfied that it should be given no more weight here.
The taxpayers in Blasdel v. Commissioner, supra at 1015-
1016, 1018, created a trust, named themselves as 2 of the trust’s
beneficiaries, and conveyed beneficial interests to 18 other
family members. Although we explicitly observed that “the donees
acquired their fractional beneficial interests subject to the
same terms and limitations as petitioners held theirs”, we
nonetheless based our decision on the nature of those terms,
without regard to any identity of rights between donors and
donees. Id. at 1018-1020; see also Hamilton v. United States,
553 F.2d 1216, 1218 (9th Cir. 1977). In addition, given the
authority granted here to A.J. Hackl as manager, we observe that
the alleged equality, when viewed from a practical standpoint, is
less than petitioners would have us believe.
Concerning the specific rights granted in the Operating
Agreement, we are unable to conclude that these afforded a - 30 -
substantial economic benefit of the type necessary to qualify for
the annual exclusion. While we are aware of petitioners’
contentions and the parties’ rather conclusory stipulations that
Treeco was a legitimate operating business entity and that
restrictive provisions in the Agreement are common in closely
held enterprises and in the timber industry, such circumstances
(whether or not true) do not alter the criteria for a present
interest or excuse the failure here to meet those criteria.
As we consider potential benefits inuring to the donees from
their receipt of the Treeco units themselves, we find that the
terms of the Treeco Operating Agreement foreclosed the ability of
the donees presently to access any substantial economic or
financial benefit that might be represented by the ownership
units. For instance, while an ability on the part of a donee
unilaterally to withdraw his or her capital account might weigh
in favor of finding a present interest, here no such right
existed. According to the Agreement, capital contributions could
not be demanded or received by a member without the manager’s
consent. Similarly, a member desiring to withdraw could only
offer his or her units for sale to the company; the manager was
then given exclusive authority to accept or reject the offer and
to negotiate terms. Hence some contingency stood between any
individual member and his or her receipt from the company of
economic value for units held, either in the form of approval - 31 -
from the current manager or perhaps in the form of removal of
that manager by joint majority action, followed by the
appointment of and approval from a more compliant manager.
Likewise, while a dissolution could entitle members to
liquidating distributions in proportion to positive capital
account balances, no donee acting alone could effectuate a
dissolution.
Moreover, in addition to preventing a donee from
unilaterally obtaining the value of his or her units from the
LLC, the Operating Agreement also foreclosed the avenue of
transfer or sale to third parties. The Agreement specified that
“No Member shall be entitled to transfer, assign, convey, sell,
encumber or in any way alienate all or any part of the Member’s
Interest except with the prior written consent of the Manager,
which consent may be given or withheld, conditioned or delayed as
the Manager may determine in the Manager’s sole discretion.”
Hence, to the extent that marketability might be relevant in
these circumstances, as potentially distinguishable on this point
from those in indirect gift cases such as Chanin v. United
States, 393 F.2d at 977, and Blasdel v. Commissioner, supra at
1021-1022 (both dismissing marketability as insufficient to
create a present interest where the allegedly marketable
property, an entity or trust interest, differed from the
underlying gifted property), the Agreement, for all practical - 32 -
purposes, bars alienation as a means for presently reaching
economic value. Transfers subject to the contingency of manager
approval cannot support a present interest characterization, and
the possibility of making sales in violation thereof, to a
transferee who would then have no right to become a member or to
participate in the business, can hardly be seen as a sufficient
source of substantial economic benefit. We therefore conclude
that receipt of the property itself, the Treeco units, did not
confer upon the donees use, possession, or enjoyment of property
within the meaning of section 2503(b).
C. Application to Income From the Gifted Property
Turning then to whether the gifts of Treeco units afforded
to the donees the right to use, possession, or enjoyment of
income therefrom, we again answer this question in the negative.
As before, broadly applicable standards and reasoning derived
from both the trust cases and the cases involving gifts to a
partnership or corporate entity call for this result.
In particular, this Court has distilled caselaw in these
areas into a three-part test for ascertaining whether rights to
income satisfy the criteria for a present interest under section
2503(b). Calder v. Commissioner, 85 T.C. at 727-728. The
taxpayer must prove, based on surrounding circumstances and the
trust agreement: “(1) That the trust will receive income, (2)
that some portion of that income will flow steadily to the - 33 -
beneficiary, and (3) that the portion of income flowing out to
the beneficiary can be ascertained.” Id.; see also Md. Natl.
Bank v. United States, 609 F.2d 1078, 1080-1081 (4th Cir. 1979).
Here, the parties stipulated that the primary business
purpose of Treeco and its successors was to acquire and manage
timberland for long-term income and appreciation, “and not to
produce immediate income.” The parties further stipulated:
“Petitioners anticipated that all three entities would operate at
a loss for a number of years, and therefore, they did not expect
that these entities would be making distributions to members
during such years.” The record then validates these assumptions
by stipulating to losses, negative cashflows, and an absence of
distributions from 1995 to April of 2001. Hence, even the first
receipt of income prong has not been established on the facts
before us.
Furthermore, even if petitioners had shown that Treeco would
generate income at or near the time of the gifts, the record
fails to establish that any ascertainable portion of such income
would flow out to the donees. Members would receive income from
Treeco only in the event of a distribution. However, the
Operating Agreement states that distributions were to be made in
the manager’s discretion. This makes the timing and amount of
distributions a matter of pure speculation and also raises again
the specter of some form of joint action to oust a manager whose - 34 -
distribution policy failed to satisfy members. As a result, the
facts in this case convince us that any economic benefit the
donees may ultimately obtain from their receipt of the Treeco
units is future, not present. In other words, the economic
benefit has been postponed in a manner contrary to the regulatory
and judicial pronouncements establishing the meaning of a present
interest gift for purposes of section 2503(b).
Additionally, we note that the fact the parties have
stipulated a value for the Treeco units does not affect the
foregoing analysis. Although petitioners mention this fact
repeatedly, it has long been established that “the crucial thing
is postponement of enjoyment, not the fact that the beneficiary
is specified and in esse or that the amount of the gift is
definite and certain.” Fondren v. Commissioner, 324 U.S. at 26-
27. Entity interest values can be based, as the facts and
circumstances indicate is the case here, on the worth of
underlying assets and the future income potential they represent,
neither of which may be presently reachable. We therefore hold
that petitioners are not entitled to exclusions under section
2503(b) for their gifts of Treeco units.
To reflect the foregoing,
Decisions will be entered
under Rule 155.