The Rest of the Story Told in the Pierre Gift Tax Case – Step Transaction Doctrine Applied

Suzanne Pierre had previously fared well in the first decision the Tax Court issued on her dispute with the IRS.  In Pierre I (133 TC No. 2) the Tax Court ruled that the existence of an LLC was to be respected for transfer tax purposes even if, prior to the transfer, the entity had been a single member LLC taxed as a disregarded entity for income tax purposes under the “check the box” regulations.

However issues remained to be decided in the case, resulting in a second Pierre decision (Pierre v. Commissioner, TC Memo 2010-106).  Suzanne transferred securities to the LLCs, and then 12 days later managed to transfer her entire interest in the LLCs to trusts for her son and granddaughter.

The appraiser that Suzanne had hired informed her that she could transfer a 9.5% interest in each trust without triggering gift taxes, so she treated that amount as gifted and had the trusts sign installment notes to purchase the remaining interests.  Income distributions from the partnership were used by the trust to pay the interest on the notes and no principal had been paid over the eight years the notes were outstanding at the time of trial.

The IRS contended that rather than a gift of an interest followed by the purchase of an interest, this was a bargain sale of a 50% interest to each trust under the step transaction doctrine.  The Tax Court found Suzanne did not give any nontax reason for structuring the transaction in this fashion and held for the IRS that under the step transaction doctrine this amounted to a single transaction.

The Court also found that, since the interests should be valued as 50% interest, the minority interest discount was reduced from 10% to 8%, even though the IRS did not produce its own expert, relying on the concession from the taxpayer’s expert that a 50% interest, due to the ability to block the appointment of a new manager, would receive less of a discount than a less than 50% interest.

However, the Court did not reduce the lack of marketability discount from the amount the taxpayer claimed on the gift tax return, noting that the IRS had not provided any contrary evidence.  The IRS had, instead of getting a valuation prepared, relied entirely on the theory that the LLC itself could be ignored.

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