Grandma sets up and transfers $4.25 million to a single-member LLC. (4). Through gifts and loans she transfers her entire interest in the single-member LLC to two different trusts created for her grandchildren. (4).
The Issue for the Tax Court
The issue to be decided is whether certain transfers of interests in a single-member limited liability company (LLC) that is treated as a disregarded entity . . . are valued as transfers of proportionate shares of the underlying assets owned by the LLC or are instead valued as transfers of interest in the LLC, and therefore, subject to valuation discounts for lack of marketability and control. (3).
[The taxpayer] argues that, for Federal gift tax valuation purposes, State law, not Federal tax law, determines the nature of a taxpayer's interest in property transferred...Accordingly...we must look to State law to determine what interest was transferred. . . . (7).
[The I.R.S.] argues that, because the LLC . . . is disregarded under the check-the-box regulations, . . . transfers of interests in the LLC should be "treated" as . . . proportionate shares of [the] LLC's [underlying] assets. . . . (6).
A fundamental premise of transfer taxation is that State law creates property rights and interests, and Federal tax law then defines the tax treatment of those property rights. See Morgan v. Commissioner, 309 U.S. 78 (1940). (9).
Pursuant to New York law [the taxpayer] did not have a property interest in the underlying assets of the LLC, which is recognized under New York law as an entity separate and apart from its members. Accordingly, there was no State law "legal interest or right" in those assets for Federal law to designate as taxable, and Federal law could not create a property right in those assets. (11).
Check-the-Box Regulations Issue
[W]hether the check-the-box regulations require us to disregard a single-member LLC, validly formed under State law, in deciding how to value and tax a donor's transfer of an ownership interest in the LLC under the Federal gift tax regime . . . . (15).
[W]e do not agree that the check-the-box regulations apply to disregard the LLC in determining how a donor must be taxed under the Federal gift tax provisions on a transfer of an ownership interest in the LLC. If the check-the-box regulations are interpreted and applied as [the I.R.S.] contends, they go far beyond classifying the LLC for tax purposes. The regulations would require that Federal law, not State law, apply to define the property rights and interests transferred by a donor . . . . [T]o conclude that because an entity elected the classification rules set forth in the check-the-box regulations, the long-established Federal gift tax regime is overturned. . . . (20).
In every case involving questions of statutory or regulatory interpretation, the starting point is the language itself. The regulations we here construe are . . . [the check-the-box regulations]. (31).
Contrary to the majority's suggestion that State law, not Federal law, defines for valuation purposes under the Federal gift tax the property rights and interests a donor transfers (see majority op. p. 19), McNamee v. Dept. of the Treasury, supra, stands for the proposition that Federal law, in the form of the check-the-box regulations, does define the property rights and interests so transferred. (41-42).
The majority fails to apply the plain language of [the check-the-box regulations], which require that a single-member LLC be disregarded for "federal tax purposes." (49).
The regulations provided that the owner of a disregarded entity is treated as the owner of its property. Likewise, the Court of Appeals for the Second Circuit, the court to which this case is appealable, has said " 'if the entity is disregarded, its activities are treated in the same manner as a sole proprietorship . . . of the owner.' " McNamee v. Dept. of Treasury, 488 F.3d 100, 107-108 (2d Cir. 2007).
For What its Worth
I agree with the Majority opinion in this case. The regulations' plain language should be respected but not out of context. The majority provides a long history of the regulations starting on p. 11. I am sure this decision will get appealed.