In the recent case of Estate of Purdue v. Commissioner, the Tax Court held in favor of a widow's estate where the IRS had sought an estate tax deficiency of over $3.1 million. The widow and her deceased husband formed an LLC and then made annual gifts of interests in the LLC to a trust for the benefit of their five adult children. The challenge by the IRS related to value of the remaining interests that Mrs. Purdue still held in the LLC at the time of her death.
The IRS claimed that the entire value of the LLC was taxable in Mrs. Purdue’s estate because she retained too many rights (e.g., right to receive distributions from the LLC) and therefore all her prior gifts of interests in the LLC during her lifetime were argued as being part of her taxable estate.
The court disagreed with the IRS due to the design of the LLC and the non-tax motivations behind its formation. In Mrs. Purdue’s situation, the LLC had been created for nontax reasons that included the intent to (i) consolidate management and control of property, (ii) avoid fractional ownership at death and (iii) protect assets from unknown creditors. Therefore, Mrs. Purdue’s estate included only the portion of the LLC that she had not previously gifted, which accordingly reduced the size of her estate, which was further reduced after applying certain valuation discounts.
Valuation discounts apply to members in an LLC because those members receive an interest in the LLC (and not the underlying assets), allowing the value of the LLC interest to be discounted due to lack of marketability (of the LLC interest) and lack of control (over the LLC’s underlying assets).
The Treasury Department indicated last year that it planned to issue proposed regulations which would significantly curtail the availability of valuation discounts for transfers of interests in family entities including a limited partnership or an LLC. To date no such regulations have been implemented. In the meantime, the window of opportunity to make use of these discounts remains. As the Tax Court pointed out in Purdue, LLCs created during this window of opportunity, however, still need to be drafted correctly and administered in a proper fashion.
- Edward D. Brown