World's Ugliest 2012 Gift Plan
World's Ugliest 2012 Gift Plan
By: Martin Shenkman
Summary: You might have seen worse, but this baby is up there. And, just like Ripley's Believe it or Not! Where "Truth is stranger than fiction," this plan was a real one. Fortunately the taxpayer appears to have been saved from disaster, but their "plan" is a great checklist of everything you don't want to do in your 2012 gift plan. While some of the items below individually could undermine the success of a gift plan, the advisers who created this winner chose to really assure as many bad facts as possible to maximize the likelihood of failure (or at least it seems so).
Form a New LLC:
This client had a limited liability company (LLC) that had been around for years, yet the advisers set up a brand new LLC to use for the gifts. If you don't have an LLC (or other suitable entity) and using an entity makes sense in your transaction, then setting up a new one is the only alternative. But setting up a new entity instead of using an existing entity will only heighten tax and asset protection risks. While the old and cold entity might have an clear business purpose, will the newly formed entity? Elsie J. Church v. US. Gifts of non-controlling interests in LLCs can qualify for valuation discounts (i.e., the value of a 20% interest in the LLC is less than 20% of the value of the underlying assets). While 20% of an LLC is worth something less than 20% of say the securities portfolio the LLC owns, securities are worth their actual value. The LLC interest may be discounted because a 20% owner cannot control the vote, distributions, etc. Using a long existing LLC, in the view of some advisers, may be more secure. If you have an asset like an operating business or rental property you certainly want it held in its own LLC to protect your other assets from a lawsuit that business or property might create. But if you have an existing investment LLC setting up a duplicative new one will only increase the costs and complexity. Good for the lawyers but not for you.
Transfer assets into the LLC 2 Days before Making Gifts:
Say you want to put assets into and LLC and then gift non-controlling LLC interests to trusts. Those non-controlling interests should be valued at a discount from the underlying asset value (see above). However, if you plop assets into the LLC just prior to the gift, the IRS will say that the gift was really of the underlying assets and that the LLC "envelope" holding those gifts should be disregarded. Shepherd v. Comr. Poof! Your hoped for discount disappears. Just like a fine wine, assets must appropriately aged to develop the discount bouquet. Two days barely makes vinegar.
Have Documents Notarized in Different States:
So you're in State A and sign your documents, but your lawyer has a notary in State B notarize a key transfer document. Hmmmmm, absent a little "Beam me up, Scotty" transporter action that just doesn't seem possible. The IRS or a creditor might raise an eyebrow as to the validity of the document and trash the entire transaction as invalid. Estate of Senda.
Put Personal Use Assets in the LLC:
If an LLC is supposed to be respected as a legitimate business and investment entity it should not own personal use assets. Putting your house into an LLC and continuing to live there without paying rent will torpedo your plan faster than you can say "Supercalifragilisticexpialidocious." Reichardt v. Commr. Well, a residence used by your family member free of rent might differ from the facts in the Reichardt case since it's not you, but free family use of personal property will torpedo the LLC just the same.
Have Lots of Back and Forth Unsubstantiated Loans:
Undocumented loans between the LLC and members and other family entities might be recharacterized as equity, compensation, gift transfers, etc. depending on the circumstances. Miller v. Comr. But an excessive amount of undocumented loans might jeopardize the integrity of the LLC.
Leave the Donor Cash Poor:
If you're left with inadequate assets after the transfer to the LLC to support yourself the transfer could be deemed a fraudulent conveyance or indicative that the LLC could not be valid as you would have to be able to retrieve cash from it to survive. In our worst case scenario the taxpayer was left with a mere $3,500 in cash in his name. That fact alone would likely torpedo the gift plan. Estate of Harper; Estate of Reichardt; Estate of Schauerhamer.
Don't Get an Appraisal:
Although four months after the purported transaction was completed the lawyer wrote the clients suggesting they obtain an appraisal of the LLC interests given. Consummating a $5 million gift without a formal appraisal of the LLC interests is certainly inadvisable. While in the recent Wandry case the appraisal was completed after the gift the transfer documents clearly limited the dollar amount specified and there was a commitment to obtain a qualified appraisal. Winging it just isn't sensible and gives no protection in the event of an audit.
Don't Sign Appropriate Post Gift Documentation:
If you gift away 80% of an LLC, there should be a post gift operating agreement signed by all the owners and confirming the ownership percentages. In this worst case scenario nothing was done for more than a year after the assignments were executed. No current operating agreement.
Be Sure the Donor Didn't Understand the Transaction:
The IRS has taken a liking to asking taxpayers to explain the transactions they were involved in. If the taxpayer had no clue the deal was done, what was done, how or why, you may as well just start praying that the taxpayer is not questioned by the IRS, or the plan will assuredly flop.
Use Effective Dates and No Real Execution Date:
Proper execution of documents to assure their effectiveness is important. Proper dating of documents to assure that the sequence of events occurred as appropriate, and that there was sufficient time between different steps of the transactions (whatever those time frames might be) is vital. If your attorney prepares key documents signed listing an effective date, but no date for the actual signature, you cannot demonstrate what time frames actually existed between the steps or the order in which the different steps in the transaction actually occurred.
Pay Personal Expenses from the LLC:
Paying personal expenses from a family entity is contrary to respecting the entity for tax and legal purposes. If practices were lax, clean them up before any transfer is made.
Don't Open an LLC Bank Account:
Without the fundamental business formality of a bank account how can the LLC pay its own bills? How can it possibly look real?
Don't Use a Defined Value Clause:
In the wake of the Wandry case, some advisers are suggesting a more frequent use of a defined value clause that establishes a gift of an intended dollar value of LLC interests rather than a percentage of LLC interests. When gifts are made of hard to value assets like LLC interests that may be discounted, especially when the LLC owns minority interests in other entities that hold hard to value real estate assets, and when you're pushing up to the line of your $5.12 million gift exemption, some type of safety valve, like a Wandry defined value clause should at minimum be discussed and considered.
Show LLC Assets on the Donor's Balance Sheet:
If you want to convince the IRS that the LLC is, in the words of Dr. Phil, the "real deal" you really should consider separate LLC financial statements, but you absolutely don't want to show your pro-rata share of underlying LLC assets on your balance sheet. That is tantamount to your almost corroborating to the IRS that there are no discounts because the gift was of underlying assets, not discountable LLC membership interests.
Don't Use Independent Professionals:
Have the CPA prepare all tax returns, determine the value of the entity interest given, use the CPA's wife as a witness, have the same CPA serve as the sole trustee of the donee trusts, don't have anyone represented by independent counsel, etc.
Believed Client was on Deathbed:
The IRS has long frowned on deathbed gifts. But documenting in an email that you believe the client was near death as the rationale for the plan is really over the top. At least make the IRS auditor earn his or her keep!
No Documentation of Capacity:
One statistic suggests that 50% of those over age 85 have some degree of cognitive impairment. If you're dealing with a donor in her late 80s should you at least have counsel corroborate that the donor had adequate capacity to sign the relevant gift and other documents? Also bear in mind that contractual capacity may be required to execute an operating agreement, assignments, trust and other documents. This is a greater level of capacity then testamentary capacity which will suffice to sign a will.
Martin Shenkman, Jonathan Blattmachr, and Robert S. Keebler just published a 200 page book entitled, "2012 Estate Planning: Tax Planning Steps to Take Now." It is now available as an ebook on www.amazon.com for $39.95 and is written for both the sophisticated client and professional adviser.