By Trisha J. English, Esq.
Winstead PC , Houston, TX
In Wimmer Est. v. Comr.,1 the Tax Court determined that donees of limited partnership interests received a substantial present economic benefit from the income of the limited partnership interests, thereby qualifying the gifts for the annual gift tax exclusion under §2503(b).
The facts are fairly straightforward. In 1996, Mr. and Mrs. Wimmer, in their capacities as trustees of trusts that they had respectively established, formed a family limited partnership and were the initial general and limited partners. The only assets of the partnership were publicly traded (and dividend-paying) stock. During the next four years, Mr. and Mrs. Wimmer made gifts of limited partnership interests to their descendants and to a trustee of a trust established for the benefit of certain of the Wimmers' grandchildren ("Grandchildren Trust").
The issue was whether, due to transfer restrictions in the partnership agreement, the gifts of limited partnership interests were present interests that qualified for the annual gift tax exclusion. The court noted that "to qualify as a present interest, a gift must confer on the donee a substantial present economic benefit by reason of use, possession, or enjoyment (1) of property or (2) of income from the property."
Transfer restrictions in the partnership agreement prevented donees from receiving a present interest in the partnership interests. As to the first prong, the court looked to the partnership agreement to determine if the donees received a present interest in the partnership interests. The partnership agreement generally restricted transfer of partnership interests and limited the instances in which a transferee could become a substitute limited partner.2 There was, however, an exception to these restrictions for transfers to related parties. Even though the transfers at issue were transfers to related parties, the Tax Court still held that the donees' rights were limited:For example, although limited partners may transfer their partnership interests to other partners and related parties…all other transfers are restricted unless certain requirements are met. Therefore the donees did not receive unrestricted and noncontingent rights to immediate use, possession, or enjoyment of the limited partnership interests themselves….
Finding that the first prong was not met, the court next turned to the second prong to determine if the donees obtained a present use, possession, or enjoyment of income from the limited partnership interests.
Donees' rights to income from the partnership satisfied the criteria for a present interest. In order to satisfy the criteria for a present interest in the income of the partnership interest under §2503(b), the estate must establish the following three criteria based on the surrounding circumstances: (1) that the partnership would generate income; (2) that some portion of that income would flow steadily to the donees; and (3) that the portion of income could be readily ascertained.
1. The partnership would generate income. With respect to the first criteria, the partnership since its inception had a history of receiving quarterly dividends. Therefore, it logically flowed that on the dates of the gifts there was an expectation that the partnership would generate income.
2. Some portion of the income would flow steadily to the donees. As to the second criteria, the court focused on the fiduciary relationship between the general partners and the trustee of the Grandchildren Trust (one of the donees) to establish that on the date of each gift some portion of partnership income was expected to flow steadily to the limited partners. In essence, because the Grandchildren Trust had no source of income other than partnership distributions, some distribution was necessary in order to pay the trust's federal income tax liabilities. The court concluded that because the general partners were obligated to distribute a portion of the partnership income each year to the trustee of the Grandchildren Trust, they were also required under the partnership agreement to make pro rata distributions to the other limited partners. Therefore, each donee of limited partnership interests could expect to receive some portion of the partnership's income.
3. The portion of income could be readily ascertained. Finally, as to the third criteria, because the partnership's assets consisted of publicly-traded stock, a limited partner could estimate the portion of income that would flow to it by reviewing the stock's dividend history, and by taking into consideration the limited partner's percentage ownership in the partnership.
Because all three criteria were met, the court held that the limited partners received a substantial present economic benefit sufficient to render the gifts of limited partnership interests present interest gifts on the date of each gift, and that such gifts qualified for the annual gift tax exclusion under §2503(b).
Comment. Whereas this case favored the taxpayer, in two prior cases, Hackl3 and Price,4 similar gifts of limited partnership interests did not qualify for the gift tax exclusion because the donees did not have a present interest in the income from the partnership. The key difference was that the partnership in Wimmer made regular income distributions. Because many partnership agreements contain provisions restricting transfers and/or restricting the ability of transferees to become limited partners, Wimmer offers guidance as to how gifts of limited partnership interests may still qualify for the gift tax exclusion.
For more information, in the Tax Management Portfolios, see Lischer, 845 T.M., Gifts, and in Tax Practice Series, see ¶6330, Gift Tax Exclusions, Deductions and Tax Computation.
1 T.C. Memo 2012-157.
2 For example, in order to transfer limited partnership interests, the general partners and at least 70% in interest of the limited partners must give prior written consent. Furthermore, a transferee will not become a substitute limited partner unless the transferring limited partner has given the transferee that right and the transferee (1) accepts and assumes all terms and provisions of the partnership agreement; (2) provides, in the case of an assignee who is a trustee, a complete copy of the applicable trust instrument authorizing the trustee to act as partner in a partnership; (3) executes such other documents as the general partners may reasonably require; and (4) is accepted as a substitute limited partner by unanimous written consent of the general partners and the limited partners.
3 Hackl v. Comr., 118 T.C. 279 (2002), aff'd, 335 F.3d 664 (7th Cir. 2003). The LLC at issue in Hackl invested in a tree farming business and did not anticipate any significant cash flow for many years.
4 Price v. Comr., T.C. Memo 2010-2. The partnership at issue in Price did not make distributions in all years and making distributions was within the general partner's discretion.
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