Court grants the government's motion in Linton v. United States of America. Carsten Hoffmann is a managing director of FMV Opinions, a valuation and financial-advisory services firm.

"A given result at the end of a straight path is not made a different result because reached by following a devious path."

So said a U.S. District Court in framing its decision last week in the case of William A. Linton and Stacy A. Linton v. United States of America [No. 2:08-cv-00227]. The District Court for the Western District of Washington had to decide whether to grant summary judgment and dismiss the Lintons' suit seeking a gift-tax refund. Summary judgment could be granted if the court found that the Lintons made indirect gifts to their children when they contributed property to WLFB Investments (the LLC ) or that their actions satisfied the "step-transaction" doctrine.

Background

William Linton formed the LLC in 2002 and contributed real estate and publicly traded securities to the entity. In January 2003, the Lintons made gifts to their children of minority-member interests, claiming a 47% discount |image1|for lack of control and lack of marketability. Also in 2003, they filed gift-tax returns reporting taxable gifts aggregating approximately $1.5 million. The gift-tax returns were audited, and the IRS concluded that taxable gifts aggregating approximately $3 million had been made. The significantly higher gift amount was based on the IRS' findings that discounts for lack of control and lack of marketability did not apply because the gifts were indirect gifts of the contributed assets to the members rather than transfers of LLC interests. The IRS further argued that even if the Lintons could establish the proper sequence of events -- namely the funding of the LLC before the gifts were made -- they still made indirect gifts under the step-transaction doctrine. Timeline

As in the Shepherd [115 TC 376, 383 (2000)], Jones [116 TC 121 (2001)] and Gross [TC Memo (2008)] decisions, a determination of whether a gift is a direct gift or an indirect gift begins with a close examination of the timing of events. Here's the timeline for Linton.

November 2002 - LLC is formed by husband 22 January 2003 - husband gives 50% of LLC to wife 22 January 2003 - husband quit claims undeveloped real property to LLC 22 January 2003 - husband signs letters authorizing transfer of securities to LLC 22 January 2003 - husband signs assignment of assets 22 January 2003 - trust agreements for the benefit of children are signed (but not dated) 22 January 2003 - documents titled "gift of interest in LLC" are signed by parents for benefit of children (but not dated)

Each of the trust agreements is irrevocable and entered into effective upon contribution of property to the trust.

When reviewing the various LLC documentation items a few months, the estate-planning attorney said he filled in the missing dates of the trust agreements and transfer agreements with a January 22, 2003 date. However, in deposition, he said that he now realized that this was a mistake and the intended date for trust formation and transfer should have been 31 January 2003.

Court reviews Shepherd, Jones and Gross cases

In Shepherd, the parents contributed real estate and securities to an entity that was formed on the same day. But the entity operating agreement was not signed by the junior generation until the next day. The Tax Court held that the conveyance of land occurred on the second day, not on the first day, stating "there was no completed gift, because there was no [recipient], and petitioner had not parted with dominion and control over the property." The Tax Court ultimately held that the taxpayer's transfers of both land and stock represented indirect gifts to each child to the extent of their respective percentage interests in the entity.

The Shepherd finding was opposite to the outcomes in Jones and Gross. There, the court decided that the owners' contributions of assets to the entities were not treated as indirect gifts. The finding was based on the notion that, in both cases, the contributing owner had taken back continuing ownership interests in exchange for the property contributed. The contributions had been properly reflected in their respective capital accounts, and the value of the other owners' interests had not been enhanced by their contribution. Only after the proper accounting of the donors' capital accounts, were transfers made to the junior generation.

Conclusion

Although the taxpayer spent a considerable amount of time arguing that the chronology of events was nebulous, in the end the court found that the "express language of these documents establishes that the trusts were created and the gifts were made on 22 January 2003; on that date, when the trust agreements were signed, percentage interests in the LLC had already been or were contemporaneously gifted to the trusts, thereby making the transfer effective." Summary judgment is granted as a matter of law.

Although not necessary, the court also commented on the fact that it found the IRS' alternative theory persuasive. This theory put forth that even if the Lintons could establish the proper sequence of events, namely funding the LLC before gifting interests, they nevertheless made indirect gifts to their children under the step transaction doctrine. Steps in a straight line might have been fine, but steps that resemble an M.C. Escher lithograph are a "devious path." -FWR

This is not intended or written to be used by any taxpayer or advisor to a taxpayer for the purpose of avoiding penalties that may be imposed upon the taxpayer or advisor by the IRS. This writing is not legal advice, nor should it be construed as such.

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