Tax Court Rules Gifts Of Family Limited Partnership Interests Qualify For Gift Tax Exclusion

The Tax Court has ruled in Estate of Wimmer v. Commissioner (T.C. Memo. 2012-157) that gifts of interests in a family limited partnership (FLP) qualified for the annual gift tax exclusion because the FLP's publicly traded, dividend-paying stock created the need and the funds for the FLP to make distributions to cover the tax obligations of partners.

As part of its continued attacks on FLPs, the IRS has argued with some success that many gifts of interests in an FLP do not qualify for the $13,000 annual gift tax exclusion, because they are not gifts of "present interest." Section 2503(b) provides the $13,000 annual exclusion from gift tax (indexed for inflation) only if the gift is a present interest. Treas. Reg. Sec. 25.2503-3(b) provides that a present interest is the unrestricted right to the immediate use, possession or enjoyment of property or the income from property.

In Wimmer, the decedent and his wife created an FLP. The FLP agreement generally restricted the transfer of partnership interests and limited the instances in which a transferee may become a substitute limited partner, but created an exception for transfers to related parties. The decedent and his wife made gifts of FLP interests in each year from 1996 through 2000 to their children, nieces and nephews, and a trust for the benefit of their grandchildren, grandnieces and grandnephews.

The FLP agreement provided that all distributions of net cash flow were to be shared among the partners in proportion to their FLP interests. The FLP assets consisted of publicly traded, dividend-paying stock. During its first three years of operation, the FLP made distributions for the payment of the partners' federal income taxes. Beginning in 1999, the FLP continually distributed all dividends, net of expenses, to the partners. In addition to the distribution of income, limited partners had access to capital account withdrawals and used such withdrawals for, among other things, paying down their residential mortgages.

The test to determine whether the transfer of property is a gift of a present interest was established by the Tax Court in 2002 in Hackl v. Commissioner (118 T.C. 279, aff'd 335 F.3d 664, 7th Cir.). To be a present interest under the Hackl test, the gift must confer on the donee a substantial present economic benefit by reason of use, possession or enjoyment of either (1) the property or (2) the income from the property. To satisfy the first requirement, the taxpayer must...