The Heckermans wanted to teach their two young children the value of “working for their money.” On the advice of legal and financial counsel, they established a trust for each child and also an Investments LLC, which was solely owned by a Family LLC. On January 11, 2002, they transferred $2.85 million in mutual funds to the Investments LLC. Notably, they also:

• Transferred 1,217.65 units in Family LLC to each of their children on Jan. 11, 2002;
• Signed gift documents stating that the assignments were effective on that date;
• Provided the IRS a document stating that the childrens’ trusts were admitted as members to the Family LLC, effective Jan. 11, 2002; and,
• Provided an appraiser the valuation (gift transfer) date of Jan. 11, 2002.

The appraiser valued each child’s minority interest in the Family LLC at $511,000, and then applied a substantial (58%) discount for lack of marketability. Listing the discounted values of the LLC transfers on their tax returns, the Heckermans concluded no gift tax was due—but the IRS begged to differ, saying the transfers were really indirect gifts of $511,000 cash to each child. Because the transfers of cash and LLC units took place on the same day, they were part of a plan to pass the cash to the kids in a tax-advantaged form, and under the step transaction doctrine, they should be collapsed into a single action.

At trial, the taxpayers tried gamely to show that the cash transfers took place before the transfers of LLC units—but in Heckerman v. Comm’r, 2009 WL 2240326 (W.D. Wash.)(July 27, 2009), the federal district court noted the “plethora” of objective evidence that all transfers took place on the same day. It also cited recent Tax Court cases to find that the transfers were not only indirect gifts of cash, but were also a single action under the step transaction doctrine.

Where can you hear the latest on FLP valuation, including the step-transaction doctrine, recently resurrected by the IRS to attack asset transfers? Register for the 2nd Annual University of San Diego School of Law Business Valuation and Tax Summit on October 9, 2009, co-sponsored by BVResources. The all-star agenda includes an FLP update, case application of DLOM methodologies (by Jim Hitchner, Linda Trugman, Jay Fishman, Kevin Yeanoplos, and Bob Duffy), plus Nancy Fannon discussing, for the first time, her new data to support calculations of the effect of shareholder taxes on value in the private markets. For more information and to register, click here.