Suzanne J. Pierre v. Commissioner , 133 T.C. No. 2 ( 2009 )

133 T.C. No. 2UNITED STATES TAX COURT
SUZANNE J. PIERRE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 753-07. Filed August 24, 2009.
P transferred cash and publicly traded securities
to LLC, a New York limited liability company, in
exchange for a 100-percent interest in LLC. P
subsequently made four transfers of her interest in LLC
to trusts established for the benefit of her son and
granddaughter: P transferred as a gift a 9.5-percent
interest in LLC to each trust and then sold a 40.5-
percent interest in LLC to each trust in exchange for a
promissory note. In valuing the transfers for Federal
gift tax purposes, P applied substantial discounts for
lack of marketability and control and therefore paid no
gift tax on the transfers.
R argues, inter alia, that the transfers should be
treated as transfers of the underlying assets of LLC
because a single-member limited liability company is a
disregarded entity under the “check-the-box”
regulations of secs. 301.7701-1 through 301.7701-3,
Proced. & Admin. Regs.
-2-
Held: For purpose of application of the Federal
gift tax, the transfers are to be valued as transfers
of interests in LLC, and LLC is not disregarded under
the “check-the-box” regulations to treat the transfers
as transfers of a proportionate share of assets owned
by LLC.
Kathryn Keneally and Meryl G. Finkelstein, for petitioner.
Lydia A. Branche, for respondent.
WELLS, Judge:1 Respondent determined deficiencies of
$1,130,216.11 and $24,969.19 in petitioner’s Federal gift tax and
generation-skipping transfer tax for 2000 and 2001, respectively.
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 pursuant to sections 301.7701-1
through 301.7701-3, Proced. & Admin. Regs.,2 known colloquially
and hereinafter referred to as the check-the-box regulations, are
valued as transfers of proportionate shares of the underlying
assets owned by the LLC or are instead valued as transfers of
1
The Chief Judge reassigned this case for Opinion and
decision to Judge Thomas B. Wells from Judge Diane L. Kroupa, who
presided over the trial. Judge Kroupa does not disagree with our
fact findings as they relate to the legal issue addressed in this
Opinion.
2
The check-the-box regulations refer to an entity with a
“single owner”. The New York statute that created the LLC in
issue refers to owners of LLCs as “members”. See N.Y. Ltd. Liab.
Co. Law art. VI (McKinney 2007). For purposes of this Opinion,
no difference in meaning is intended by the use of the terms
“owner” and “member”.
-3-
interests in the LLC, and, therefore, subject to valuation
discounts for lack of marketability and control.3
FINDINGS OF FACT
Some of the facts and certain exhibits have been stipulated
by the parties. The facts stipulated by the parties are
incorporated in this Opinion and are so found. Petitioner
resided in New York at the time she filed the petition.
Petitioner received a $10 million cash gift from a wealthy
friend in 2000. Petitioner wanted to provide for her son Jacques
Despretz (Mr. Despretz) and her granddaughter Kati Despretz (Ms.
Despretz) but was concerned about keeping her family’s wealth
intact. Richard Mesirow (Mr. Mesirow) helped petitioner develop
a plan to achieve her goals.
On July 13, 2000, petitioner organized the single-member
Pierre Family, LLC (Pierre LLC). Petitioner respected the
formalities of formation in the State of New York, and Pierre LLC
was validly formed under New York law. Petitioner did not elect
to treat Pierre LLC as a corporation for Federal tax purposes by
filing a Form 8832, Entity Classification Election, and therefore
filed no corporate return for Pierre LLC.
3
In this Opinion, we decide only the legal issue set forth
above. The following issues were argued by the parties but will
be addressed in a separate opinion: (1) Whether the step
transaction doctrine applies to collapse the separate transfers
to the trusts and (2) the appropriate valuation discount, if any.
-4-
On July 24, 2000, petitioner created the Jacques Despretz
2000 Trust and the Kati Despretz 2000 Trust (sometimes
collectively referred to as the trusts).
On September 15, 2000, petitioner transferred $4.25 million
in cash and marketable securities to Pierre LLC.
On September 27, 2000, 12 days after funding Pierre LLC,
petitioner transferred her entire interest in Pierre LLC to the
trusts. She first gave a 9.5-percent membership interest in
Pierre LLC to each of the trusts to use a portion of her then-
available credit amount and her GST exemption. She then sold
each of the trusts a 40.5-percent membership interest in exchange
for a secured promissory note. The notes each had a face amount
of $1,092,133. Petitioner set this amount using the appraisal by
James F. Shuey of James F. Shuey & Associates that valued a 1-
percent nonmanaging interest in Pierre LLC at $26,965. Mr. Shuey
determined the value of a 1-percent interest by applying a 30-
percent discount to the value of Pierre LLC’s underlying assets.
However, petitioner admits that because of an error in valuing
the underlying assets, a discount of 36.55 percent was used in
valuing the LLC interest for gift tax purposes.
Petitioner filed a Form 709, United States Gift (and
Generation-Skipping Transfer) Tax Return, for 2000 and reported
the gift to each trust of a 9.5-percent Pierre LLC interest. She
reported the value of the taxable gift to each trust as $256,168
-5-
(determined by multiplying a 9.5-percent interest times the
$26,965 appraised value of a 1-percent nonmanaging interest in
Pierre LLC).
Respondent examined petitioner’s gift tax return and issued
a deficiency notice for 2000 and 2001. Respondent determined
that petitioner’s gift transfers of the 9.5-percent Pierre LLC
interests to the trusts are properly treated as gifts of
proportionate shares of Pierre LLC assets valued at $403,750
each, not as transfers of interests in Pierre LLC. Respondent
further determined that petitioner made gifts to the trusts of
the 40.5-percent interests in Pierre LLC to the extent that the
value of 40.5 percent of the underlying assets of Pierre LLC
exceeded the value of the promissory notes from the trusts.
Respondent valued each of these transfers at $629,117 after
taking into account the value of the promissory notes.
OPINION
I. The Parties’ Contentions
The parties do not dispute that Pierre LLC was a validly
formed LLC pursuant to New York State law, which recognized
Pierre LLC as an entity separate from petitioner under New York
State law.4 They also agree that, at the time of the transfers,
4
Although respondent argues that the step transaction
doctrine should apply to the gift and sale transfers in issue,
respondent explicitly limits the proposed application of the step
transaction doctrine to the events of Sept. 27, 2000, and thus
(continued...)
-6-
Pierre LLC is to be disregarded as an entity separate from its
owner “for federal tax purposes” under the check-the-box
regulations. The parties disagree, however, about whether the
check-the-box regulations require that Pierre LLC be disregarded
for Federal gift tax valuation purposes.
Respondent argues that, because Pierre LLC is a single-
member LLC that is treated as a disregarded entity under the
check-the-box regulations, petitioner’s transfers of interests in
Pierre LLC should be “treated” as transfers of cash and
marketable securities, i.e., proportionate shares of Pierre LLC’s
assets, rather than as transfers of interests in Pierre LLC, for
purposes of valuing the transfers to determine Federal gift tax
liability. Accordingly, respondent contends that petitioner made
gifts equal to the total value of the assets of Pierre LLC less
the value of the promissory notes she received from the trusts.5
Petitioner 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 and the legal
rights inherent in that property interest. Accordingly,
4
(...continued)
does not advocate applying the step transaction doctrine to
disregard Pierre LLC. As noted above, the step transaction
issues will be addressed in a separate opinion.
5
Respondent argues that the four transfers in issue should
be collapsed into one transfer pursuant to the step transaction
doctrine. As noted above, this issue will be addressed in a
separate opinion.
-7-
petitioner contends that we must look to State law to determine
what property interest was transferred and then value the
property interest actually transferred to apply the Federal gift
tax provisions to that value to ascertain gift tax liability.
Petitioner argues that, under New York State law, a membership
interest in an LLC is personal property, and a member has no
interest in specific property of the LLC. N.Y. Ltd. Liab. Co.
Law sec. 601 (McKinney 2007). Accordingly, petitioner argues
that she properly valued the transferred interests in Pierre LLC
for purposes of valuing her transfers to the trusts and that she
properly applied lack of control and lack of marketability
discounts in valuing6 the transferred LLC interests.
Petitioner also contends that respondent bears the burden of
proof on all fact issues because she has met the requirements of
section 7491.7 As the only issue decided in this Opinion is
decided as a matter of law, we need not decide in this Opinion
which party bears the burden of proof.8
6
As noted above, issues of valuation will be addressed in a
separate opinion.
7
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue.
8
The issues regarding which party bears the burden of proof
will be addressed, if necessary, in a separate opinion.
-8-
II. The Historical Gift Tax Valuation Regime
We begin with a brief summary of the longstanding statutes,
regulations, and caselaw that constitute the Federal gift tax
valuation regime. Section 2501(a) imposes a tax on the transfer
of property by gift. The amount of a gift of property is the
value of the property at the date of the gift. Sec. 2512(a). It
is the value of the property passing from the donor that
determines the amount of the gift. Sec. 25.2511-2(a), Gift Tax
Regs. “The value of the property is the price at which such
property would change hands between a willing buyer and a willing
seller, neither being under any compulsion to buy or to sell, and
both having reasonable knowledge of the relevant facts.” Sec.
25.2512-1, Gift Tax Regs. Where property is transferred for less
than adequate and full consideration in money or money’s worth,
the amount of the gift is the amount by which the value of the
property transferred exceeds the value of the consideration
received. Sec. 2512(b).
In addition to the statutes and regulations, there is
significant Supreme Court precedent interpreting them and guiding
the implementation of the Federal gift and estate tax.9 The
Supreme Court, in Bromley v. McCaughn, 280 U.S. 124 (1929), held
9
The Federal estate tax is interpreted in pari materia with
the Federal gift tax. See Estate of Sanford v. Commissioner, 308
U.S. 39, 44 (1939) (citing Burnet v. Guggenheim, 288 U.S. 280,
286 (1933)).
-9-
that the imposition of a gift tax is within the constitutional
authority of Congress. The holding in Bromley turned on a
finding that the gift tax is an excise tax rather than a direct
tax. As the Supreme Court stated in Bromley v. McCaughn, supraat 135-136:
The general power to “lay and collect taxes, duties,
imposts, and excises” conferred by Article I, § 8 of
the Constitution, and required by that section to be
uniform throughout the United States, is limited by § 2
of the same article, which requires “direct” taxes to
be apportioned, and section 9, which provides that “no
capitation or other direct tax shall be laid unless in
proportion to the census” directed by the Constitution
to be taken. * * *
* * * a tax imposed upon a particular use of property
or the exercise of a single power over property
incidental to ownership, is an excise which need not be
apportioned * * *
* * * [The gift tax] is a tax laid only upon the
exercise of a single one of those powers incident to
ownership, the power to give the property owned to
another. * * *
The Supreme Court has also provided guidance as to the
appropriate roles of Federal and State law in the valuation of
transfers. 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). It is well
established that the Internal Revenue Code creates “‘no property
rights but merely attaches consequences, federally defined, to
rights created under state law.’” United States v. Nat. Bank of
-10-
Commerce, 472 U.S. 713, 722 (1985) (quoting United States v.
Bess, 357 U.S. 51, 55 (1958)). In Morgan v. Commissioner, supra
at 80-81, the Supreme Court stated:
State law creates legal interests and rights.
The federal revenue acts designate what interests or
rights, so created, shall be taxed. Our duty is to
ascertain the meaning of the words used to specify the
thing taxed. If it is found in a given case that an
interest or right created by local law was the object
intended to be taxed, the federal law must prevail no
matter what name is given to the interest or right by
state law.
In Morgan, the Court disregarded the State law
classification of a power of appointment as “special” where the
rights associated with that power of appointment under State law
(i.e., the power to appoint to anyone, including the holder’s
estate and creditors) were properly classified under Federal law
as a general power of appointment. As is standard in Federal
estate and gift tax cases, the interest was created by State law,
respected by the Court, and taxed pursuant to the Federal estate
and gift tax provisions. In short, the Court ignored the label,
not the interest created, and determined whether the interest
fell within the Federal statute. This Court, in Knight v.
Commissioner, 115 T.C. 506 (2000), followed the Supreme Court
precedent discussed above. As we said in Knight v. Commissioner,
supra at 513 (citing United States v. Nat. Bank of Commerce,
supra at 722, United States v. Rodgers, 461 U.S. 677, 683 (1983),
and Aquilino v. United States, 363 U.S. 509, 513 (1960)): “State
-11-
law determines the nature of property rights, and Federal law
determines the appropriate tax treatment of those rights.”
Pursuant to New York law petitioner did not have a property
interest in the underlying assets of Pierre LLC, which is
recognized under New York law as an entity separate and apart
from its members. N.Y. Ltd. Liab. Co. Law sec. 601.
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.
Consequently, pursuant to the historical Federal gift tax
valuation regime, petitioner’s gift tax liability is determined
by the value of the transferred interests in Pierre LLC, not by a
hypothetical transfer of the underlying assets of Pierre LLC.
III. The Check-the-Box Regulations and Single-Member LLCs
We next turn to the question of whether the check-the-box
regulations alter the historical Federal gift tax valuation
regime discussed above. Pursuant to the Internal Revenue Code,
the income of a C corporation is subject to double taxation (once
at the corporate level and once at the shareholder level) while
the income of partnerships and sole proprietorships is taxed only
once (at the individual taxpayer level). See Littriello v.
United States, 484 F.3d 372, 375 (6th Cir. 2007). An LLC is a
relatively new business structure, created by State law, that has
some features of a corporation (i.e., limited personal liability)
-12-
and some features of a partnership (i.e., management flexibility
and pass-through taxation). McNamee v. Dept. of the Treasury,
488 F.3d 100, 107 (2d Cir. 2007). Section 7701, underpinning the
check-the-box regulations, defines entities for purposes of the
Internal Revenue Code “where not otherwise distinctly expressed
or manifestly incompatible with the intent thereof”. Section
7701 does not make it clear whether an LLC falls within the
definition of a partnership, a corporation, or a disregarded
entity taxed as a sole proprietorship.
Before the promulgation of the check-the-box regulations,
the proliferation of revenue rulings, revenue procedures, and
letter rulings relating to the classification of LLCs and
partnerships for Federal tax purposes made the existing
regulations “unnecessarily cumbersome to administer”. Dover
Corp. & Subs. v. Commissioner, 122 T.C. 324, 330 (2004). Those
existing regulations, known as the “Kintner Regulations”, had
been in place since 1960.10 In McNamee v. Dept. of the Treasury,
10
In Richlands Med. Association v. Commissioner, T.C. Memo.
1990-660, affd. without published opinion 953 F.2d 639 (4th Cir.
1992), we summarized the “Kintner Regulations” as follows:
The Kintner Regulations * * * set forth six
characteristics ordinarily found in a corporation which
distinguish it from other organizations. Those
characteristics are (1) associates, (2) an objective to
carry on business and divide the gains therefrom, (3)
continuity of life, (4) centralization of management,
(5) limited liability, and (6) free transferability of
interests. The regulations go on to note that, in some
(continued...)
-13-
supra at 108-109, the Court of Appeals for the Second Circuit,
the court that would be the venue for any appeal of the instant
case absent stipulation to the contrary, stated:
The Kintner regulations had been adequate during the
first several decades after their adoption. But, as
explained in the 1996 proposal for their amendment, the
Kintner regulations were complicated to apply,
especially in light of the fact that
many states ha[d] revised their statutes to
provide that partnerships and other unincorporated
organizations may possess characteristics that
traditionally have been associated with
corporations, thereby narrowing considerably the
traditional distinctions between corporations and
partnerships under local law.
Simplification of Entity Classification Rules, 61 Fed.
Reg. 21989, 21989-90 (proposed May 13, 1996). * * *
To simplify the classification of hybrid entities, such as
LLCs, the check-the-box regulations were promulgated. Section
301.7701-1(a)(1), Proced. & Admin. Regs., provides:
10
(...continued)
cases, other factors may be found which may be
significant in classifying an organization.
* * * Although the regulations cite the Supreme Court
decision in Morrissey v. Commissioner, 296 U.S. 344(1935), for the proposition that corporate status will
exist if an organization “more nearly resembles” a
corporation than a partnership or trust, the
regulations adopt a mechanical test for determination
of corporate status. Under that test, each of the four
characteristics “apparently bears equal weight in the
final balancing,” Larson v. Commissioner, * * * [66
T.C.] at 172, and an entity will not be taxed as a
corporation unless it possesses more corporate than
noncorporate characteristics. Section 301.7701-
2(a)(3), Proced. and Admin. Regs.; Larson v.
Commissioner, supra at 185. * * *
-14-
Classification of organizations for federal tax
purposes.--(a) * * * --(1) * * * The Internal Revenue
Code prescribes the classification of various
organizations for federal tax purposes. Whether an
organization is an entity separate from its owners for
federal tax purposes is a matter of federal tax law and
does not depend on whether the organization is
recognized as an entity under local law. [Emphasis
added].
Section 301.7701-3(a) and (b), Proced. & Admin. Regs., provides:
Classification of certain business entities.--(a) * * *
A business entity * * * can elect its classification
for federal tax purposes as provided in this section.
An eligible entity * * * with a single owner can elect
to be classified as an association or to be disregarded
as an entity separate from its owner. Paragraph (b) of
this section provides a default classification for an
eligible entity that does not make an election. * * *
(b) Classification of eligible entities that do
not file an election.--(1) * * * Except as provided in
paragraph (b)(3) of this section, unless the entity
elects otherwise, a domestic eligible entity is--
* * * * * * *
(ii) Disregarded as an entity separate from its
owner if it has a single owner.
[Emphasis added.]
Accordingly, the default classification for an entity with a
single owner is that the entity is disregarded as an entity
separate from its owner. Sec. 301.7701-3(b)(1)(ii), Proced. &
Admin. Regs. There is no question that the phrase “for federal
tax purposes” was intended to cover the classification of an
entity for Federal tax purposes, as the check-the-box regulations
were designed to avoid many difficult problems largely associated
with the classification of an entity as either a partnership or a
-15-
corporation; i.e., whether it should be taxed as a pass-through
entity or as a separately taxed entity. Simplification of Entity
Classification Rules, 61 Fed. Reg. 21989-21990 (May 13, 1996).
The question before us now is whether 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 described above.
IV. Whether the Check-the-Box Regulations Alter the Historical
Federal Gift Tax Valuation Regime
Respondent points to a number of cases as support for the
proposition that, pursuant to the check-the-box regulations,
valid State law restrictions must be ignored for the purpose of
determining the interest being transferred under the Federal
estate and gift tax regime. Respondent cites McNamee v. Dept. of
the Treasury, 488 F.3d 100 (2d Cir. 2007), a case decided by the
Court of Appeals for the Second Circuit. However, respondent’s
reliance on McNamee is misplaced. In McNamee, the Court of
Appeals held that State law cannot abrogate the Federal tax
obligations of the owner of a disregarded entity under the check-
the-box regulations. Id. at 111 (citing Littriello v. United
States, 484 F.3d at 379). In issue in McNamee was the
requirement to pay withholding taxes for a single-member LLC’s
employees. The Court of Appeals held that the owner of the
single-member LLC there in issue was liable for the disregarded
-16-
entity’s taxes; it did not hold that an entity is to be
disregarded in deciding what property interests are transferred
under State law for Federal gift tax valuation purposes when an
owner of an entity disregarded under the check-the-box
regulations transfers an interest in that entity.11
Similarly, respondent’s reliance on Shepherd v.
Commissioner, 115 T.C. 376 (2000), affd. 283 F.3d 1258 (11th Cir.
2002), and Senda v. Commissioner, 433 F.3d 1044 (8th Cir. 2006),
affg. T.C. Memo. 2004-160, is not convincing, as the facts of
those cases differ significantly from the facts of the instant
case. In Shepherd v. Commissioner, supra at 384, we looked to
applicable State law to decide what property rights were
conveyed. In Shepherd, the property the taxpayer possessed and
transferred was his interests in leased land and bank stock. Id.
at 385. Because the creation of the taxpayer’s sons’ partnership
interests preceded the completion of the gift to the partnership,
we found that the taxpayer made indirect gifts to his sons of his
11
For the same reasons, Littriello v. United States, 484
F.3d 372 (6th Cir. 2007), and Med. Practice Solutions, LLC v.
Commissioner, 132 T.C. __ (Mar. 31, 2009) (an Opinion of this
Court following McNamee v. Dept. of the Treasury, 488 F.3d 100(2d Cir. 2007)), are not controlling for the purpose of
determining what interest is being transferred under the Federal
gift tax valuation regime. Both of these cases, like McNamee,
involve the classification of a single-member LLC (i.e., whether
it is a pass-through entity or a separately taxed entity) for
purposes of liability for employment taxes. Neither case
addresses the valuation of transferred interests in a single-
member LLC for purposes of Federal gift tax valuation.
-17-
interests in the land and bank stock. Id. at 389. The Court of
Appeals for the Eleventh Circuit, in its opinion affirming
Shepherd, highlighted the distinction between the facts of
Shepherd and a hypothetical set of facts (more similar to the
facts under consideration in the the instant case) when it noted
that
Thus, instead of completing a gift of land to a
preexisting partnership in which the sons were not
partners and then establishing the partnership
interests of his sons (which would result in a gift of
a partnership interest), Shepherd created a partnership
in which his sons held established shares and then gave
the partnership a taxable gift of land (making it an
indirect gift of land to his sons).
Shepherd v. Commissioner, 283 F.3d at 1261 (fn. ref. omitted).
In the instant case, petitioner completed a gift of cash and
securities to Pierre LLC at a time when the trusts were not
members of Pierre LLC and then later transferred interests in
Pierre LLC to the trusts, which established the interests of the
trusts in Pierre LLC.12 Accordingly, Shepherd is consistent with
the requirement that State law determines the interest being
12
Petitioner contributed the stock and securities to Pierre
LLC approximately 12 days before she transferred the Pierre LLC
interests to the trusts. In Holman v. Commissioner, 130 T.C. 170(2008), we found that the indirect gift analysis of Shepherd v.
Commissioner, 115 T.C. 376 (2000), affd. 283 F.3d 1258 (11th Cir.
2002), and Senda v. Commissioner, T.C. Memo. 2004-160, affd. by
433 F.3d 1044 (8th Cir. 2006), did not apply where assets were
transferred to a partnership 5 days before the gifts of the
partnership interests.
-18-
transferred. In the instant case, as discussed above, pursuant
to New York law, petitioner transferred interests in Pierre LLC.
Senda v. Commissioner, supra, is also distinguishable. In
Senda, the taxpayers were unable to establish whether they had
transferred partnership interests to their children before or
after they contributed stock to the partnership. Citing Shepherd
v. Commissioner, supra, the Court of Appeals for the Eighth
Circuit noted that the sequence was critical “because a
contribution of stock after the transfer of partnership interests
is an indirect gift”. Senda v. Commissioner, supra at 1046.
Both Shepherd and Senda stand for the proposition that a
transfer of property to a partnership for less than full and
adequate consideration may represent an indirect gift to the
other partners. In the instant case, petitioner contributed the
cash and securities to Pierre LLC before transfers to the trusts
were made and the trusts became members of Pierre LLC.
Consequently, Shepherd and Senda are not controlling.
Petitioner relies heavily on Estate of Mirowski v.
Commissioner, T.C. Memo. 2008-74. We do not find Estate of
Mirowski to be controlling because the Commissioner did not rely
on the check-the-box regulations with respect to the transfer of
the LLC interests there in issue. However, we do note that in
Estate of Mirowski we refused to adopt an interpretation that
“reads out of section 2036(a) in the case of any single-member
-19-
LLC the exception for a bona fide sale * * * that Congress
expressly prescribed when it enacted that statute.” If
respondent’s interpretation were to prevail in the instant case,
such an interpretation could create a similar result.13
The multistep process of determining the nature and amount
of a gift and the resulting gift tax under the Federal gift tax
provisions described above, i.e., (1) the determination under
State law of the property interest that the donor transferred,
(2) the determination of the fair market value of the transferred
property interest and the amount of the transfer to be taxed, and
(3) the calculation of the Federal gift tax due on the transfer,
is longstanding and well established. Neither the check-the-box
regulations nor the cases cited by respondent support or compel a
conclusion that the existence of an entity validly formed under
applicable State law must be ignored in determining how the
transfer of a property interest in that entity is taxed under
Federal gift tax provisions.
While we accept that the check-the-box regulations govern
how a single-member LLC will be taxed for Federal tax purposes,
i.e., as an association taxed as a corporation or as a
disregarded entity, we do not agree that the check-the-box
13
As noted above, see supra note 9, the Federal estate tax
must be interpreted in pari materia with the Federal gift tax.
-20-
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 respondent 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 for valuation purposes under the Federal gift tax regime.
We do not accept that the check-the-box regulations apply to
define the property interest that is transferred for such
purposes. The question before us (i.e., how a transfer of an
ownership interest in a validly formed LLC should be valued under
the Federal gift tax provisions) is not the question addressed by
the check-the-box regulations (i.e., whether an LLC should be
taxed as a separate entity or disregarded so that the tax on its
operations is borne by its owner). To conclude that because an
entity elected the classification rules set forth in the check-
the-box regulations, the long-established Federal gift tax
valuation regime is overturned as to single-member LLCs would be
“manifestly incompatible” with the Federal estate and gift tax
statutes as interpreted by the Supreme Court. See sec. 7701.
We note that Congress has enacted provisions of the Internal
Revenue Code, see secs. 2701, 2703, that disregard valid State
-21-
law restrictions in valuing transfers. Where Congress has
determined that the “willing buyer, willing seller” and other
valuation rules are inadequate, it expressly has provided
exceptions to address valuation abuses. See chapter 14 of the
Internal Revenue Code, sections 2701 through 2704, which
specifically are designed to override the standard “willing
buyer, willing seller” assumptions in certain transactions
involving family members.
By contrast, Congress has not acted to eliminate entity-
related discounts in the case of LLCs or other entities generally
or in the case of a single-member LLC specifically. In the
absence of such explicit congressional action and in the light of
the prohibition in section 7701, the Commissioner cannot by
regulation overrule the historical Federal gift tax valuation
regime contained in the Internal Revenue Code and substantial and
well-established precedent in the Supreme Court, the Courts of
Appeals, and this Court, and we reject respondent’s position in
the instant case advocating an interpretation that would do so.
Accordingly, we hold that petitioner’s transfers to the trusts
should be valued for Federal gift tax purposes as transfers of
interests in Pierre LLC and not as transfers of a proportionate
share of the underlying assets of Pierre LLC.
-22-
To reflect the foregoing,
An appropriate order will
be issued.
Reviewed by the Court.
COHEN, FOLEY, VASQUEZ, THORNTON, MARVEL, GOEKE, WHERRY,
GUSTAFSON, and MORRISON, JJ., agree with this majority opinion.
-23-
COHEN, Judge, concurring: As the author of the Opinion for
the Court in Med. Practice Solutions, LLC v. Commissioner, 132
T.C. __ (2009), I write to explain why my agreement with the
majority opinion here is consistent with the conclusion in that
case, which followed McNamee v. Dept. of the Treasury, 488 F.3d
100 (2d Cir. 2007). Briefly, I agree with the majority that
McNamee and Med. Practice Solutions, LLC are classification cases
that appropriately applied the check-the-box regulations of
section 301.7701-3(b)(1)(ii), Proced. & Admin. Regs., in deciding
whether the single owner/member of an LLC or the LLC was liable
for employment taxes on the wages of the employees of the business
in question. In contrast, this case involves the issue of the
valuation for transfer tax purposes of certain interests in a
single-owner LLC that that owner transferred. See majority op. p.
15. (McNamee and Med. Practice Solutions, LLC, along with
Littriello v. United States, 484 F.3d 372 (6th Cir. 2007), and
others cited in Med. Practice Solutions, LLC, will be referred to
as the employment tax cases).
The check-the-box regulations might be applied to determine
for gift tax purposes whether the owner of a single-member LLC or
the LLC is the transferor of the assets used in the business or
the activities for which the LLC was formed. In that event, the
determination would parallel the determination in the employment
tax cases as to who is liable for the Federal tax in dispute and
-24-
would consider whether the LLC should be “disregarded” under those
regulations. The only transfer at issue here, however, is the
transfer by the owner of the LLC of certain interests that she
held in that LLC.
Transfer tax disputes, including this one, more frequently
involve differences over the fair market value of property, and
fair market value is determined by applying the “willing buyer,
willing seller” standard to the property transferred. See
majority op. pp. 8-11. Where the property transferred is an
interest in a single-member LLC that is validly created and
recognized under State law, the willing buyer cannot be expected
to disregard that LLC. See, e.g., Knight v. Commissioner, 115
T.C. 506, 514 (2000) (“We do not disregard * * * [a] partnership
because we have no reason to conclude from this record that a
hypothetical buyer or seller would disregard it.”).
Of course, Congress has the ability to, and on occasion has
opted to, modify the willing buyer, willing seller standard. See,
e.g., secs. 2032A, 2701, 2702, 2703, 2704; Holman v. Commissioner,
130 T.C. 170, 191 (2008) (applying section 2703 to disregard
restrictions in a partnership agreement). In Kerr v.
Commissioner, 113 T.C. 449, 470-474 (1999), affd. 292 F.3d 490(5th Cir. 2002), we explained that the special valuation rules
were a targeted substitute for the complexity, breadth, and
vagueness of prior section 2036(c). We reaffirmed the willing
-25-
buyer, willing seller standard, Kerr v. Commissioner, supra at
469, and concluded that the special provision in section 2704(b)
did not apply to disregard the partnership restrictions in issue,
id. at 473; see also Estate of Strangi v. Commissioner, 115 T.C.
478, 487-489 (2000), affd. on this issue, revd. and remanded on
other grounds 293 F.3d 279 (5th Cir. 2002).
The majority opinion, majority op. pp. 13-15, discusses the
adoption of the check-the-box regulations as a targeted substitute
for the complexity of the Kintner regulations in classifying
hybrid entities and thereby determining the tax consequences to
those entities and their owners of the business or the activities
for which those entities were formed. A targeted solution to a
particular problem should not be distorted to achieve a
comprehensive overhaul of a well-established body of law.
If the regulations expressly provided that single-owner LLCs
would be disregarded in determining the identity of the property
transferred and the value of that transferred property, we could
debate the validity of the regulations and the degree of deference
to be given to various expressions of an agency’s position. Here
we are dealing only with respondent’s litigating position. The
majority does not question the validity of the check-the-box
regulations. The majority holds only that those regulations do
not control the valuation issue in this case. See majority op.
pp. 19-20.
-26-
The argument that the majority opinion disregards the plain
meaning of the phrase “for federal tax purposes” in section
301.7701-3(a), Proced. & Admin. Regs., is unpersuasive. The plain
meaning of the text of a regulation is the starting point for
determining the meaning of that regulation. See Walker Stone Co.
v. Secy. of Labor, 156 F.3d 1076, 1080 (10th Cir. 1998) (“When the
meaning of a regulatory provision is clear on its face, the
regulation must be enforced in accordance with its plain
meaning.”). We see here, however, (1) ambiguity in the specific
phrase “federal tax purposes” and (2) ambiguity in the term
“disregarded”, both of which make plain meaning elusive.
First, the regulation does not provide that an entity will be
disregarded “for all Federal tax purposes”. Instead, the
regulation implements a statute that, by its terms, applies except
where “manifestly incompatible with the intent” of the Internal
Revenue Code. Sec. 7701(a). The language of the regulation
requires a determination of which “federal tax purposes” are
implicated and whether a given purpose might be manifestly
incompatible with the Internal Revenue Code.
Second, the regulation states that an entity will be
“disregarded as an entity separate from its owner”. Sec.
301.7701-3(a) and (b)(1)(ii), Proced. & Admin. Regs. (emphasis
added). That sentence might mean that a disregarded entity is
exempt from tax, that its transactions are disregarded and
-27-
therefore not reported for tax purposes, or that transfers of
interests in the entity are disregarded for Federal gift tax
purposes and not taxed. While none of those meanings is likely,
the ambiguity is inherent. Of course, the regulation must be
interpreted in the light of the other principles of the Internal
Revenue Code. Those other principles include the valuation
principles discussed in the majority opinion. Respondent’s
proposed application of the regulation is manifestly incompatible
with those principles.
The majority’s approach is consistent with the principle that
a regulation will be interpreted to avoid conflict with a statute.
See LaVallee Northside Civic Association v. V.I. Coastal Zone
Mgmt. Commn., 866 F.2d 616, 623 (3d Cir. 1989); see also Smith v.
Brown, 35 F.3d 1516, 1526 (Fed. Cir. 1994); Phillips Petroleum Co.
v. Commissioner, 97 T.C. 30, 35 (1991), affd. without published
opinion 70 F.3d 1282 (10th Cir. 1995). It is also consistent with
the express limitation of section 7701(a) on the scope of
regulations that define terms. See majority op. p. 21. The
majority’s interpretation of the scope of the check-the-box
regulations harmonizes the classification purpose of those
regulations with the statutory rules and case precedents that
firmly establish the meaning of fair market value in transfer tax
cases and the willing buyer, willing seller standard as the
hallmark of that meaning.
-28-
Some final words about deference. As the majority opinion
indicates, majority op. p. 12, section 7701(a) precludes the
application of the definitions of the terms in that section where
they are “manifestly incompatible with the intent” of the Internal
Revenue Code. This case does not involve the question in Chevron
U.S.A. Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837(1984), of deference to the Commissioner’s interpretation of a
statute that the Commissioner is charged with administering.
Nothing in the check-the-box regulations or in the cases cited by
respondent persuades us that those regulations require us to
disregard a single-owner LLC where, as is the case here, to do so
would be “manifestly incompatible” with the intent of other
provisions of the Internal Revenue Code.
Judge Halpern in his dissenting opinion does not address the
majority’s conclusion that respondent’s interpretation of the
regulation is manifestly incompatible with other provisions of the
Code. He asserts that “respondent’s position in this case * * *
is consistent with the Commissioner’s administrative position for
at least 10 years”. Dissenting op. p. 35. He cites Rev. Rul. 99-
5, 1999-1 C.B. 434, which describes the Federal income tax
consequences of a transfer under sections 721-723, 1001(a), and
1223. The ruling and the sections cited do not deal with transfer
taxes generally or gift tax specifically. Moreover, the Internal
Revenue Service has reversed itself with respect to application of
-29-
the check-the-box regulations in employment tax situations and has
adopted new rules as of January 1, 2009. See McNamee v. Dept. of
the Treasury, 488 F.3d at 109; Littriello v. United States, 484
F.3d 372 (6th Cir. 2007); Med. Practice Solutions, LLC v.
Commissioner, 132 T.C. at __ (slip op. at 7).
We have never accorded deference to the Commissioner’s
litigating position, as contrasted to (1) contemporaneous
expressions of intent when the regulations were adopted and (2)
consistent administrative interpretations before the litigation.
See Gen. Dynamics Corp. & Subs. v. Commissioner, 108 T.C. 107,
120-121 (1997). Respondent does not argue here that respondent’s
interpretation of the regulation is entitled to deference.
Neither the cases--Oteze Fowlkes v. Adamec, 432 F.3d 90, 97 (2d
Cir. 2005), United States v. Miller, 303 F.2d 703, 707 (9th Cir.
1962), and Lantz v. Commissioner, 132 T.C. ___, ___ n.10 (2009)
(slip op. at 23-24)--nor the so-called hornbook law on which Judge
Halpern relies in his dissenting opinion requires us to give
deference to respondent’s litigating position that the check-the-
box regulations apply in this case. We have no reason to believe
that respondent’s litigating position here is an interpretation of
those regulations that reflects “the * * * fair and considered
judgment [of the Secretary of the Treasury] on the matter in
question.” Auer v. Robbins, 519 U.S. 452, 462 (1997) (where the
Supreme Court of the United States ordered the Secretary of Labor
-30-
to file an amicus brief in a case between private litigants
involving the interpretation of a regulation that the Secretary
had promulgated, the Supreme Court accepted the Secretary’s
interpretation since in the circumstances of the case “There is
simply no reason to suspect that the interpretation does not
reflect the agency’s fair and considered judgment on the matter in
question.”). Moreover, Judge Halpern’s reliance on a footnote in
Lantz v. Commissioner, supra, is misplaced. We there concluded
that a taxpayer’s pursuit of a particular type of relief would be
fruitless in the face of the Commissioner’s position, the validity
of which had not been challenged. Neither case cited in that
footnote adopts the litigating position of the party as distinct
from preexistent and consistent administrative interpretations.
See Bowles v. Seminole Rock & Sand Co., 325 U.S. 410, 414 (1945);
Phillips Petroleum Co. v. Commissioner, 101 T.C. 78, 97 (1993),
affd. without published opinion 70 F.3d 1282 (10th Cir. 1995).
WELLS, FOLEY, VASQUEZ, THORNTON, MARVEL, GOEKE, WHERRY, and
GUSTAFSON, JJ., agree with this concurring opinion.
-31-
HALPERN, J., dissenting:
I. Introduction
We here face a task common in courts reviewing the actions of
an administrative agency; i.e., we must construe an agency’s
statute and regulations and consider the agency’s interpretation
of those authorities. I agree with neither the approach the
majority takes nor the conclusion it reaches. I agree with much
of what Judge Kroupa writes but wish to emphasize how my approach
differs from that of the majority.
II. The Language of the Regulation
That regulations, like statutes, are interpreted pursuant to
canons of construction is a basic principle of regulatory
interpretation. E.g., Black & Decker Corp. v. Commissioner, 986
F.2d 60, 65 (4th Cir. 1993), affg. T.C. Memo. 1991-557. In every
case involving questions of statutory or regulatory
interpretation, the starting point is the language itself. E.g.,
Bd. of Educ. v. Harris, 622 F.2d 599, 608 (2d Cir. 1979) (quoting
Greyhound Corp. v. Mt. Hood Stages, Inc., 437 U.S. 322, 330
(1978)). The regulations we here construe are sections 301.7701-1
through -3, Proced. & Admin. Regs. (the so-called check-the-box
regulations). We are particularly concerned with the language in
section 301.7701-2(a), Proced. & Admin. Regs., describing what
happens when a business entity with only one owner is disregarded
as an entity separate from that owner; viz, “its activities are
-32-
treated in the same manner as a sole proprietorship, branch, or
division of the owner.” Given that Pierre LLC’s owner,
petitioner, is an individual, Pierre LLC’s activities are treated
in the same manner as those of a sole proprietorship. See id.Missing from the instruction (sometimes, the activities
instruction), however, is its scope. Ostensibly, section
301.7701-1(a)(1), Proced. & Admin. Regs., provides that scope,
stating that the activities instruction applies for “federal tax
purposes”.
Section 2501(a) imposes a tax on the transfer of property by
gift. The tax is an excise tax imposed on the value of the
property transferred. See id.; Dickman v. Commissioner, 465 U.S.
330, 340 (1984) (“The gift tax is an excise tax on transfers of
property”.). Section 2512(a) provides that the amount of a gift
of property is the value of the property on the date of the gift.
Respondent argues that, because petitioner elected to treat Pierre
LLC as a disregarded entity, petitioner is properly “treated as
transferring cash and marketable securities, as opposed to Pierre
LLC interests, for federal gift tax purposes.” Petitioner
responds: “[T]he issue is the gift tax treatment of transfers of
interests in an LLC”, “not the imposition of a tax due as a result
of the activities of a single-member LLC.” In effect, petitioner
argues that the activities instruction is irrelevant to any
inquiry concerning her transfers of interests in the LLC, since
-33-
that inquiry concerns her own activities and not her LLC’s
activities.
Petitioner’s position bespeaks a distinction between a sole
proprietor and her business that the activities instruction will
not bear. A sole proprietorship is generally understood to have
no legal identity apart from the proprietor. 18 C.J.S.,
Corporations, sec. 4 (2007) (“A sole proprietorship has no
separate legal existence or identity apart from the sole
proprietor.”). Judge Richard A. Posner applied that rule of unity
nicely in Smart v. Intl. Bhd. of Elec. Workers, Local 702, 315
F.3d 721, 723 (7th Cir. 2002): “Two plaintiffs are listed, but
one is a sole proprietorship and the other the proprietor, so they
are one, not two, in the eyes of the law * * *, and the one is the
proprietor * * * not the proprietorship.” I would read the
activities instruction as plainly saying that Pierre LLC and
petitioner constitute only one actor (i.e., petitioner) for
Federal tax purposes (which, of course, encompass the Federal gift
tax), so that any gift by petitioner of an interest in Pierre LLC
is, as respondent argues, a gift of an interest in that LLC’s cash
and marketable securities.1 Others may find the activities
1
Treating the transfer of an interest in a single-member
disregarded entity as a transfer of an interest in the entity’s
assets is in no way inconsistent with applying the “willing
buyer, willing seller” standard for valuation purposes, see sec.
25.2512-1, Gift Tax Regs., as Judge Cohen suggests in her
concurring opinion, p. 24. The willing buyer and willing seller
(continued...)
-34-
instruction to be ambiguous, so I will proceed as if the
instruction is not clear from the plain language of the
regulation. I reject (and the majority does not contend) that the
regulation plainly precludes considering the LLC’s property (or at
least interests therein) as the property petitioner transferred
when she transferred interests in the LLC.
III. The Intent of the Secretary
If we accept that the activities instruction is ambiguous,
then we must construe that provision. With respect to that task:
“It is axiomatic that any regulation should be construed to
effectuate the intent of the enacting body.” United States v.
Miller, 303 F.2d 703, 707 (9th Cir. 1962). Indeed, hornbook law
holds:
In construing an administrative rule or regulation,
the court must necessarily look to the administrative
construction thereof where the meaning of the words used
is in doubt, and the courts will ordinarily show
deference to such construction and give it controlling
weight.
1
(...continued)
are purely hypothetical figures. See Estate of Newhouse v.
Commissioner, 94 T.C. 193, 218 (1990). That the hypothetical
willing buyer is deemed to purchase an interest in the entity’s
assets (to value a hypothetical gift of that interest) is not
inconsistent with the fact that a real buyer (and, by extension,
a donee) would receive an interest in what has become a two-
member unincorporated entity; i.e., for Federal tax purposes, a
partnership. See sec. 301.7701-3(f)(2), Proced. & Admin. Regs.
Thus, respondent’s position does not require the real buyer to
disregard the LLC, for it is an interest in an LLC with which he
winds up.
-35-
73 C.J.S., Public Administrative Law and Procedure, sec. 212
(2004) (emphasis added); accord Oteze Fowlkes v. Adamec, 432 F.3d
90, 97 (2d Cir. 2005) (“An agency’s interpretation of its own
statute and regulation must be given controlling weight unless it
is plainly erroneous or inconsistent with the regulation.”
(citations and internal quotation marks omitted)); Lantz v.
Commissioner, 132 T.C. __, __ n.10 (2009) (slip op. at 23-24 n.10)
(the same).
There is ample evidence that the Secretary, in the person of
the Commissioner, construes the activities instruction to require
that the wrapper be disregarded in determining the property the
owner of a single-member disregarded entity transfers when she
transfers an interest in the entity. That is, of course,
respondent’s position, which, because it is consistent with the
Commissioner’s administrative position for at least 10 years,
cannot be dismissed as a mere litigating position.2
Implementation of the check-the-box regulations has required the
Commissioner to issue numerous interpretations. Ten years ago, in
Rev. Rul. 99-5, 1999-1 C.B. 434, the Commissioner addressed the
Federal income tax consequences of the sale by A, the owner of a
2
In Lantz v. Commissioner, 132 T.C. __, __ (2009) (slip op.
at 35) (Halpern, J. dissenting), I dismissed the Commissioner’s
interpretation of sec. 301.9100-1(c), Proced. & Admin. Regs., as
no more than a litigating position without merit, since it was
“‘plainly erroneous’ and ‘inconsistent with the regulation’”.
That is not so here.
-36-
single-member disregarded entity (an LLC), of a 50-percent
ownership interest in the entity to B, with the result that the
disregarded entity was converted into a partnership. The
Commissioner held that B’s purchase of 50 percent of A’s ownership
interest in the LLC is treated as the purchase of a 50-percent
interest in each of the LLC’s assets, “which are treated as held
directly by A for federal tax purposes.” Id. Therefore, the
Commissioner continued: “Under § 1001, A recognizes gain or loss
from the deemed sale of the 50% interest in each asset of the LLC
to B.” Id. In the intervening 10 years, the Commissioner has
issued numerous letter rulings consistent with, and relying on,
his interpretation in Rev. Rul. 99-5, supra, that a transfer by
the owner of all or a part of his interest in a single-member
disregarded entity is to be treated as the transfer by the owner
of a proportional interest in the entity’s assets.3 Rev. Rul. 99-
3
E.g., Priv. Ltr. Rul. 200825008 (Mar. 7, 2008) (limited
partnership’s distribution of membership interests in LLC, a
single-member disregarded entity, “will be treated as a
distribution of LLC’s assets and liabilities to the Partners”);
Priv. Ltr. Rul. 200824009 (Mar. 6, 2008) (trust’s distribution to
beneficiaries A and B of interests in X, a single-member
disregarded entity, “should have been treated as a non-taxable
pro rata distribution of d% of X’s assets to A and e% of X’s
assets to B * * * as if such assets had been distributed outright
from Trust to A and B”); Priv. Ltr. Rul. 200709036 (Nov. 28,
2006) (“Although Taxpayer transferred its interest in * * *, a
disregarded entity, the sale of such interest is treated as a
sale of the assets of the disregarded entity for federal income
tax purposes.”); Priv. Ltr. Rul. 200251008 (Sept. 11, 2002) (For
purposes of sec. 1031 like-kind exchange provisions: “[T]ransfer
of all the interest in * * * [disregarded entity] will be treated
(continued...)
-37-
5, supra, and the letter rulings are cited not as precedent, see
sec. 6110(k)(3), but to show the Commissioner’s consistency over a
decade in disregarding the wrapper and treating the transfer of an
interest in a single-member disregarded entity as a transfer of an
interest in the disregarded entity’s assets, see, e.g., Hanover
Bank v. Commissioner, 369 U.S. 672, 686 (1962) (“[Private letter]
rulings do reveal the interpretation put upon the statute by the
agency charged with the responsibility of administering the
revenue laws.”). Granted, the interpretations address sales and
other dispositions for purposes of the income tax, and the
Commissioner apparently has made no interpretation particular to
section 2501(a) and the gift tax. Yet, as the Court of Appeals
for the District of Columbia Circuit recently observed in Murphy
v. IRS, 493 F.3d 170, 185 (D.C. Cir. 2007) (admittedly an income
tax case, but the court was speaking generally about gifts): “A
gift is the functional equivalent of a below-market sale”. See
also sec. 25.2512-8, Gift Tax Regs. (“Transfers reached by the
gift tax * * * embrace * * * sales, exchanges, and other
dispositions of property for * * * [an inadequate]
consideration”.). Simply put, the difference between a sale and a
gift is a difference in degree, not in kind.
3
(...continued)
as a transfer of the assets of * * * [disregarded entity].”).
-38-
Given the assumed ambiguity of the activities instruction in
section 301.7701-2(a), Proced. & Admin. Regs., and the deference
we show to the Secretary’s construction of his regulations, I
accept respondent’s reading of the activities instruction as a
plausible construction. That is, because petitioner elected to
treat Pierre LLC as a disregarded entity, petitioner is properly
“treated as transferring cash and marketable securities, as
opposed to Pierre LLC interests, for federal gift tax purposes.”
I next consider the validity of the regulation.
IV. Chevron Deference
I review the validity of the regulation because, although the
majority denies that it seeks to invalidate the regulation, I
believe that it does not simply reject the meaning respondent
ascribes to the activities instruction but, rather, accepts that
meaning and rejects the activities instruction itself as an
invalid construction of the statute.4
4
The majority at least conditionally accepts respondent’s
reading of the check-the-box regulations: “If the check-the-box
regulations are interpreted and applied as respondent contends,
they go far beyond classifying the LLC for tax purposes.”
Majority op. p. 20. Indeed, the majority speculates that the
result of respondent’s reading would be to “[overturn] the long-
established Federal gift tax valuation regime * * * as to single-
member LLCs”. Majority op. p. 20. That, the majority concludes,
“would be ‘manifestly incompatible’ with the Federal estate and
gift tax statutes as interpreted by the Supreme Court. See sec.
7701.” Majority op. p. 20. The majority thus seems to accept
respondent’s reading of the check-the-box regulations but to
conclude that that reading, and thus the activities instruction
itself, is invalid because “manifestly incompatible” with the
(continued...)
-39-
The validity of the check-the-box regulations, at least as
they applied to imposing employment tax obligations directly on
the owner of a single-member disregarded entity, has been upheld
by this Court, Med. Practice Solutions, LLC v. Commissioner, 132
T.C. __ (2009), and two U.S. Courts of Appeals, McNamee v. Dept.
of the Treasury, 488 F.3d 100 (2d Cir. 2007), and Littriello v.
United States, 484 F.3d 372 (6th Cir. 2007).5 Barring stipulation
to the contrary, appeal of this case will lie to the Court of
Appeals for the Second Circuit. See sec. 7482(b)(1)(A), (2).
In McNamee, the taxpayer had elected to treat his single-
member LLC as a disregarded entity. The Commissioner sought to
recover employment taxes from the taxpayer that the LLC had failed
to pay, on the ground that the LLC was disregarded for Federal tax
purposes. The taxpayer objected that no regulation could deprive
him of the protection from liability that local law afforded him
as a member of an LLC and argued that the check-the-box
regulations “‘directly contradict the relevant statutory
provisions of the Internal Revenue Code’”. McNamee v. Dept. of
4
(...continued)
Internal Revenue Code. In this section of this separate opinion,
I show that the regulation in issue, including the activities
instruction, is a valid interpretation of the statute. In sec.
III., supra, of this separate opinion, I have set forth the
reasons respondent’s reading of that regulation must be accepted.
5
For employment taxes related to wages paid on or after
Jan. 1, 2009, a disregarded entity is treated as a corporation
for purposes of employment tax reporting and liability. Sec.
301.7701-2(c)(2)(iv), Proced. & Admin. Regs.
-40-
the Treasury, supra at 104. The relevant statutory provisions
were the first three paragraphs of section 7701(a), defining the
terms “Person”, “Partnership”, and “Corporation”. Id. at 106.6
In upholding the check-the-box regulations against challenge
in McNamee v. Dept. of the Treasury, supra at 105, the Court of
Appeals applied the following standard:
In reviewing a challenge to an agency regulation
interpreting a federal statute that the agency is
charged with administering, the first duty of the courts
is to determine “whether the statute’s plain terms
‘directly addres[s] the precise question at issue.’”
National Cable & Telecommunications Ass’n v. Brand X
Internet Services, 545 U.S. 967, 986 * * * (2005) * * *
(quoting Chevron U.S.A. Inc. v. Natural Resources
Defense Council, Inc., 467 U.S. 837, 843 * * * (1984)).
“If the statute is ambiguous on the point, we defer . .
6
In pertinent part, sec. 7701(a) provides as follows:
SEC. 7701. DEFINITIONS.
(a) When used in this title, where not otherwise
distinctly expressed or manifestly incompatible with
the intent thereof--
(1) Person.--The term “person” shall be
construed to mean and include an individual, a
trust, estate, partnership, association, company
or corporation.
(2) Partnership * * *.--The term
“partnership” includes a syndicate, group, pool,
joint venture, or other unincorporated
organization, through or by means of which any
business, financial operation, or venture is
carried on, and which is not, within the meaning
of this title, a trust or estate or a corporation
* * *
(3) Corporation.--The term “corporation”
includes associations * * *
-41-
. to the agency’s interpretation so long as the
construction is ‘a reasonable policy choice for the
agency to make.’” National Cable, 545 U.S. at 986 * * *
(quoting Chevron, 467 U.S. at 845 * * *). * * *
The Court of Appeals found the definitions ambiguous with
respect to the classification of single-member LLCs. Id. at 106-
107. Emphasizing the taxpayer’s choice in having his LLC
disregarded or treated as a corporation, the court concluded that
the check-the-box regulations “[provided] a flexible response to a
novel business form” and “are [not] arbitrary, capricious, or
unreasonable.” Id. at 109. In other words, notwithstanding the
protection from the liabilities of his LLC that Mr. McNamee
enjoyed under local law, see id. at 107, nothing in the relevant
section 7701(a) definitions deprived the Secretary of the
authority to write a regulation permitting Mr. McNamee to waive
that protection, at least as it pertained to the employment tax
liabilities of the entity, in exchange for escaping the double
taxation that would result if he failed to make that waiver, see
id. at 109, 111. The Court of Appeals thus rejected Mr. McNamee’s
contention that the limited liability rights he enjoyed under
local law protected him from the Commissioner’s action to collect
his LLC’s unpaid payroll taxes. Id. at 111.
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,
-42-
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. In other words, the Court of Appeals in
McNamee construed the check-the-box regulations to modify the
bundle of rights that Mr. McNamee enjoyed under local law and that
constituted ownership of the LLC.
We are not at this point discussing the meaning of the
activities instruction, having settled that in section III.,
supra, of this separate opinion. We are considering only the
validity of the regulation, section 301.7701-2(a), Proced. &
Admin. Regs., setting forth that instruction. In the light of
McNamee v. Dept. of the Treasury, supra,7 I find that the first
three paragraphs of section 7701(a), which, as in that case,
appear to be the relevant statutory provisions, do not plainly
speak to the question of whether, for gift tax purposes, the
Secretary may write a regulation requiring that the wrapper be
disregarded in determining what property the owner of a single-
member disregarded entity transfers when she transfers an interest
in the entity. As to the question of what constitutes the bundle
of rights enjoyed by the owner of a single-member disregarded
7
In considering the persuasive value of another court’s
opinion, we must consider not only the result but the rationale
for that result. See Seminole Tribe of Fla. v. Florida, 517 U.S.
44, 67 (1996) (“When an opinion issues for the Court, it is not
only the result but also those portions of the opinion necessary
to that result by which we are bound.”).
-43-
entity, the Court of Appeals clearly stated that, at least for
payroll tax purposes (under the preamendment version of the
regulation), the limited liability that local law accorded the
owner is ignored. McNamee v. Dept. of the Treasury, 488 F.3d at
111. Indeed, section 301.7701-1(a)(1), Proced. & Admin. Regs.,
provides: “Whether an organization is an entity separate from its
owners for federal tax purposes is a matter of federal tax law and
does not depend on whether the organization is recognized as an
entity under local law.” If the definitions in section 7701(a)(1)
through (3) are consistent with disregarding one right in the
bundle of rights enjoyed by the owner of a single-member
disregarded entity, why are they not consistent with disregarding
more than one right in that bundle; indeed, why are they not
consistent with disregarding the entirety of the bundle (i.e., the
wrapper) that separates the owner from the underlying assets?
McNamee thus convinces me that, in the context of this case, the
check-the-box regulations are not arbitrary, capricious, or
unreasonable, and, therefore, are valid.
As I point out in section III., supra, of this separate
opinion, the Commissioner has plainly taken the position that,
pursuant to the check-the-box regulations, for purposes of the
income tax, the wrapper is disregarded and the owner of a single-
member disregarded entity transferring an interest in the entity
is deemed to transfer an interest in the underlying assets of the
-44-
entity. Neither petitioner nor the majority suggests that
transfers of interests in single-member disregarded entities
cannot be treated as described. While the income tax provisions
of the Internal Revenue Code are not to be construed as though
they were in pari materia with the gift tax provisions,
Farid-Es-Sultaneh v. Commissioner, 160 F.2d 812, 814 (2d Cir.
1947), revg. 6 T.C. 652 (1946), there is nothing in the
definitions in section 7701(a)(1) through (3) of “Person”,
“Partnership”, and “Corporation” that indicates that those terms
should have different meanings for purposes of the income and gift
tax provisions of the Internal Revenue Code.
While the majority does not acknowledge that it is addressing
the validity of the check-the-box regulations, I believe that it
is rejecting the activities instruction as an invalid construction
of the statute. See supra note 4 and accompanying text. Its
reason for doing so is that “the Commissioner cannot by regulation
overrule the historical Federal gift tax valuation regime
contained in the Internal Revenue Code and substantial and well-
established precedent in the Supreme Court, the Courts of Appeals,
and this Court”. Majority op. p. 21. While certainly the
Secretary cannot by regulation overrule the Internal Revenue Code,
judicial construction of a statute must, except in one instance,
give way to later administrative construction:
A court’s prior judicial construction of a statute
trumps an agency construction otherwise entitled to
-45-
Chevron deference only if the prior court decision holds
that its construction follows from the unambiguous terms
of the statute and thus leaves no room for agency
discretion. * * *
Natl. Cable & Telecomms. Association v. Brand X Internet Servs.,
545 U.S. 967, 982 (2005).
Moreover, while application of the check-the-box regulations
to section 2501(a) may well result in a radical departure from
settled rules, as the majority suggests, see majority op. p. 21,
the majority fails to acknowledge that, at the time of their
adoption, the check-the-box regulations represented a radical
departure for income tax purposes from prior caselaw and
regulatory precedent, beginning with the seminal Supreme Court
case of Morrissey v. Commissioner, 296 U.S. 344 (1935). The
Supreme Court in Morrissey used various factors to classify
business trusts as either true trusts or associations taxable as
corporations (associations). Subsequent regulations extended the
factors approach to the classification of other business entities.
The check-the-box regulations, in effect, overrule Morrissey by
providing that, with certain exceptions, an unincorporated
organization comprising two or more associates may elect its
classification, as a partnership or corporation, for Federal tax
purposes, regardless of the number of corporate characteristics it
possesses under State (or foreign) law. Moreover, the right of an
unincorporated single-member organization with a preponderance of
corporate characteristics, which constitutes an entity separate
-46-
from its owner under State (or foreign) law, to elect to be
disregarded for Federal income tax purposes was unprecedented
under the then-existing law.8 The check-the-box regulations thus
constituted a radical departure from existing jurisprudence that
prompted many commentators to question their validity. See Dover
Corp. & Subs. v. Commissioner, 122 T.C. 324, 331 n.7 (2004). That
concern has been put to rest by McNamee v. Dept. of the Treasury,
488 F.3d 100 (2d Cir. 2007), Littriello v. United States, 484 F.3d
372 (6th Cir. 2007), and Med. Practice Solutions, LLC v.
Commissioner, 132 T.C. __ (2009), all of which concerned single-
member disregarded entities. If the check-the-box regulations
trump Supreme Court precedent regarding the role of State law in
determining entity classification for Federal income or employment
tax purposes, then surely they must also supersede judicial
precedent respecting State law concepts of property rights for
8
See, e.g., Hynes v. Commissioner, 74 T.C. 1266, 1286
(1980) (State law trust with a single beneficiary classified as
an association because it possessed a preponderance of corporate
characteristics, including associates and a joint profit motive);
Barnette v. Commissioner, T.C. Memo. 1992-371 (German GmbH wholly
owned by U.S. corporation classified as an association because it
possessed a preponderance of the remaining four corporate
characteristics after disregarding the two corporate
characteristics absent from both one-man corporations and sole
proprietorships; viz, “associates” and an objective to carry on a
business for “joint” profit), affd. without published opinion 41
F.3d 667 (11th Cir. 1994); see also Wirtz & Harris, “Tax
Classification of the One-Member Limited Liability Company”, 59
Tax Notes 1829 (June 28, 1993).
-47-
Federal gift (and estate) tax purposes. Yet that is precisely the
conclusion the majority denies.
Respondent’s interpretation of section 301.7701-2(a), Proced.
& Admin. Regs., is a valid construction of section 7701(a)(1)
through (3).
V. Conclusion
As stated above, section 2501(a) imposes a tax on the
transfer of property by gift and section 2512(a) provides that the
amount of a gift of property is the value of the property on the
date of the gift. We are here required to identify for purposes
of those provisions the property petitioner transferred when she
conveyed two 9.5-percent interests in Pierre LLC to two trusts.
Respondent argues that, because petitioner elected to treat Pierre
LLC as a disregarded entity, she is properly treated as
transferring two 9.5-percent undivided interests in the LLC’s
assets rather than two 9.5-percent interests in the LLC itself.
Respondent relies on the check-the-box regulations as authority to
so identify the property petitioner transferred. After applying
traditional tools of statutory and regulatory construction to the
pertinent language of the regulations, I agree with respondent as
to the identity of the property transferred.
In conclusion, I note that, when identifying the property
transferred for purposes of the gift tax, applying the check-the-
box regulations in the manner respondent construes them will not
-48-
always be adverse to taxpayers. If the donor transfers a
controlling interest in her single-member disregarded entity
holding, say, real property, the discount attaching to the
undivided interest in the real property deemed transferred may
exceed the discount, if any, attaching to the controlling interest
nominally transferred.9 The check-the-box regulations put the
choice of entity classification in the hands of the taxpayer.
That the taxpayer bears any burden along with the benefits seems
only fair.
KROUPA and HOLMES, JJ., agree with this dissenting opinion.
9
Here it appears that petitioner has not claimed a discount
on account of any undivided interest in property transferred.
- 49 -
KROUPA, J., dissenting: The majority opinion allows an
octogenarian taxpayer to give away $4.25 million in cash and
marketable securities at a substantial discount in gift taxes
because she put them in a limited liability company (LLC), despite
a regulation telling us that “for federal tax purposes,” that LLC
should be “disregarded.” The majority is either ignoring the
plain language of the regulation or silently invalidating it. I
must respectfully dissent.
The majority fails to apply the plain language of sections
301.7701-1 through 301.7701-3, Proced. & Admin. Regs.
(collectively the check-the-box regulations), which require that a
single-member LLC be disregarded for “federal tax purposes.” As
the trier of fact, I find no fault with the facts upon which the
majority addresses the legal issue. I take exception, however, to
how the majority frames the legal issue. Neither party argued
that the regulations are invalid. Yet the majority has, in
effect, invalidated the check-the-box regulations for Federal gift
tax purposes without providing the necessary legal analysis to do
so.
I. The Plain Language of the Check-the-Box Regulations
The check-the-box regulations provide that an “entity with a
single owner can elect to be classified as an association or to be
disregarded as an entity separate from its owner.” Sec. 301.7701-
3(a), Proced. & Admin. Regs. The regulations further provide that
- 50 -
“[w]hether an organization is an entity separate from its owners
for federal tax purposes is a matter of federal tax law and does
not depend on whether the organization is recognized as an entity
under local law.”1 Sec. 301.7701-1(a)(1), Proced. & Admin. Regs.
(emphasis added). The crux of my dispute with the majority is how
the majority interprets these provisions.
The majority ignores the plain language of the check-the-box
regulations and holds instead that Pierre LLC must be respected as
an entity separate from petitioner for Federal gift tax purposes.
The majority fails to discuss, however, what it means for an
entity not to be “separate” from its owner. The regulations
provide that the owner of a disregarded entity is treated as the
owner of its property. See sec. 301.7701-3(g)(1)(iii) and (iv),
Proced. & Admin. Regs. Likewise, the Court of Appeals for the
Second Circuit, the court to which this case is appealable,2 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 the Treasury, 488 F.3d 100, 107-108 (2d Cir.
1
The Commissioner has set forth specific, limited exceptions
in the regulations to this general rule that took effect after
the year at issue. See sec. 301.7701-2(c)(2)(iii), (iv), and
(v), Proced. & Admin. Regs. He has also issued Chief Counsel
Advice 199930013 (Apr. 18, 1999) concluding that a single-member
LLC could not be disregarded for collection purposes under secs.
6321 and 6331.
2
Petitioner resided in New York when she filed the petition.
See sec. 7482(b)(1)(A).
- 51 -
2007) (quoting section 301.7701-2(a), Proced. & Admin. Regs.).
Yet the majority ignores these authorities and minimizes the
check-the-box regulations as simply rules of classification for
Federal income tax purposes. See majority op. pp. 11-15, 20. In
doing so, the majority limits the phrase “federal tax purposes” to
Federal income tax purposes. See majority op. pp. 19-20. The
majority’s interpretation is wrong for several reasons.
First, the check-the-box regulations do not read “for federal
income tax purposes.” Instead, the regulations are drafted
broadly. The check-the-box regulations apply to the entire Code.
See sec. 7701(a). Had the drafters of the check-the-box
regulations intended that they apply only for income tax purposes,
the drafters would have used the phrase “federal income tax
purposes.” This phrase is used extensively throughout the
regulations. See, e.g., sec. 1.6050K-1(e)(2), Income Tax Regs.;
sec. 53.4947-1(b)(2)(iii), Foundation Excise Tax Regs.; sec.
301.6362-5(c)(1)(i), Proced. & Admin. Regs. The drafters
expressed their intent when they chose not to limit the
regulations’ scope to Federal income tax.
In addition, the drafters could have specifically excluded
gift tax from the regulations’ scope had the drafters intended
that result. They did not do so when the regulations were
originally drafted. See T.D. 8697, 1997-1 C.B. 215. They also
did not do so when the regulations were subsequently amended
- 52 -
specifically to exclude employment and certain excise taxes from
the regulations’ scope concerning disregarded entity status. See
sec. 301.7701-2(c)(2)(iv) and (v), Proced. & Admin. Regs.; T.D.
9356, 2007-2 C.B. 675 (effective January 1, 2009). Tellingly,
the preamble to the amended regulations states that single-owner
entities “generally would continue to be treated as disregarded
entities for other federal tax purposes” after amendment. See
Notice of Proposed Rulemaking, 70 Fed. Reg. 60475 (Oct. 18, 2005).
I fail to see how “for other federal tax purposes” means “for
other Federal tax purposes except gift tax purposes.”
The check-the-box regulations expressly tell us to treat the
owner of a single-member LLC as the owner of its assets. Sec.
301.7701-3(g)(1)(iii) and (iv), Proced. & Admin. Regs. In
addition, the owner of a disregarded entity that elects to have
the entity treated as a corporation is deemed to have contributed
all of the assets and liabilities of the entity to a corporation
in exchange for stock. Sec. 301.7701-3(g)(1)(iv), Proced. &
Admin. Regs. Similarly, a single-member corporation that elects
to be disregarded is treated as distributing all of its assets and
liabilities to its single owner. Sec. 301.7701-3(g)(1)(iii),
Proced. & Admin. Regs. The check-the-box regulations consistently
- 53 -
treat single owners who choose noncorporate status for their LLCs
as holding the property of these disregarded entities.3
The majority also fails to address other guidance from the
Commissioner that treats the owner of a single-member LLC as the
owner of its underlying property. Rev. Rul. 99-5, 1999-1 C.B.
434, describes the Federal tax consequences when a disregarded
single-member LLC becomes an entity with more than one owner and
is classified as a partnership for Federal tax purposes. The
ruling requires that the single owner be treated as selling an
interest in each of the assets if an interest in the LLC is sold.
Id. The ruling also states that, if the interest is obtained
through a capital contribution, the single owner is treated as
having contributed all of the assets of the LLC to the new
partnership for an interest. Id. In both instances, the single
owner is treated as the owner of the assets of the LLC as required
under the check-the-box regulations.
The majority further ignores the Commissioner’s consistent
treatment of single-member LLC owners as the owners of the LLC’s
underlying assets. The Commissioner has issued numerous private
3
There is nothing radical about this. It is essentially a
limited form of piercing the corporate veil “for federal tax
purposes.” The State-law concept of piercing the corporate veil
means, and the regulations echo, that a “court will disregard the
corporate entity * * * and treat as identical the corporation and
the individual or individuals owning all its stock and assets.”
14 N.Y. Jur.2d Business Relationships sec. 34 (2009).
- 54 -
letter rulings on this issue.4 For example, the owner of a
single-member LLC is treated as owning the LLC’s underlying assets
for purposes of determining like-kind exchange treatment on the
exchange of property under section 1031(a)(1), though the owner
has no State law property interest in the LLC’s assets.5 See
Priv. Ltr. Rul. 200732012 (May 11, 2007); Priv. Ltr. Rul.
200251008 (Sept. 11, 2002); Priv. Ltr. Rul. 200131014 (May 2,
2001); Priv. Ltr. Rul. 200118023 (Jan. 31, 2001); Priv. Ltr. Rul.
199911033 (Dec. 18, 1998); Priv. Ltr. Rul. 9807013 (Nov. 13,
1997); Priv. Ltr. Rul. 9751012 (Sept. 15, 1997). Despite the
Commissioner’s consistent treatment of single owners as the owners
of the LLCs’ underlying property, the majority insists that the
check-the-box regulations do not apply to determine what property
the single owner owns for Federal gift tax purposes. See majority
op. p. 20.
I know of no provision in the Code that requires us to treat
the term “property” used in section 1031(a)(1) differently for
4
Private letter rulings may be cited to show the practice of
the Commissioner. See Rowan Cos. v. United States, 452 U.S. 247,
261 n.17 (1981); Hanover Bank v. Commissioner, 369 U.S. 672, 686-
687 (1962); Dover Corp. & Subs. v. Commissioner, 122 T.C. 324,
341 n.12 (2004).
5
This treatment has not been limited to like-kind exchange
situations. See Priv. Ltr. Rul. 200134025 (May 22, 2001) (single
member of a disregarded entity is treated as the owner of
property it receives for purposes of the exemptions under sec.
514(b)(1)(A) and (c)(9)); Priv. Ltr. Rul. 9739014 (June 26, 1997)
(a single-member LLC is a qualified subchapter S shareholder
because the LLC is disregarded under the regulations).
- 55 -
purposes of section 2501, which imposes a tax on the transfer of
property by gift. The Supreme Court has already told us that the
meaning of the word “property” in the Code is a Federal question
and Federal courts are “in no way bound by state courts’ answers
to similar questions involving state law.” United States v.
Craft, 535 U.S. 274, 288 (2002). The majority’s reliance on what
it calls the longstanding gift tax regime to create such a
difference addresses neither the plain language nor the intent of
the check-the-box regulations.
II. The Majority Invalidates the Regulations for Federal Gift
Tax Purposes
The majority concludes that the check-the-box regulations do
not apply for Federal gift tax purposes. See majority op. p. 20.
I disagree. I do not minimize a plain language interpretation of
the regulations as merely respondent’s litigating position. To do
so promotes a distinction without a difference. Instead, I
interpret “federal tax purposes” to mean “federal tax purposes,”
including Federal gift taxes.
The majority, in effect, invalidates the check-the-box
regulations to the extent that the term “federal tax purposes”
encompasses Federal gift tax. The majority does not, however,
provide the necessary analysis to do so. How could they, given
that this Court and the Courts of Appeals for the Second and Sixth
Circuits have recently blessed the regulations as “eminently
reasonable”? McNamee v. Dept. of the Treasury, 488 F.3d at 109;
- 56 -
Littriello v. United States, 484 F.3d 372, 378 (6th Cir. 2007);
see Med. Practice Solutions, LLC v. Commissioner, 132 T.C. __
(2009). Instead, the majority concludes that the Commissioner
cannot by regulation overrule the Federal gift tax regime as
interpreted by this Court and others. See majority op. p. 21.
The majority must provide further analysis. An agency may
promulgate regulations that overcome the judiciary’s prior
construction of a statute, even an entire “regime’s” worth of
construction, unless that prior construction followed from the
statute’s unambiguous terms. See Natl. Cable & Telecomms.
Association v. Brand X Internet Servs., 545 U.S. 967, 982 (2005);
Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S.
837, 863-864 (1984) (an agency may change its prior interpretation
of a statute to meet changing circumstances); Dickman v.
Commissioner, 465 U.S. 330, 343 (1984) (“it is well established
that the Commissioner may change an earlier interpretation of the
law, even if such a change is made retroactive in effect”). Thus,
the majority’s reliance on the longstanding gift tax regime before
the issuance of the check-the-box regulations is not enough to
invalidate the regulations if the related statute is ambiguous.
The Court of Appeals for the Second Circuit has already held
that section 7701 is ambiguous as to the Federal tax treatment of
single-member LLCs. McNamee v. Dept. of the Treasury, supra at
107. Further, the court concluded that the check-the-box
- 57 -
regulations reasonably interpret, and fill gaps in, an ambiguous
statute and are entitled to deference under Chevron U.S.A., Inc.
v. Natural Res. Def. Council, Inc., supra. McNamee v. Dept. of
the Treasury, supra at 105-107; see Littriello v. United States,
supra at 376-378. The majority ignores this relevant Second
Circuit precedent and concludes, without discussion of any degree
of deference, that an entity’s classification for income tax
purposes is irrelevant to how a donor must be taxed under the
Federal gift tax provisions on a transfer of an ownership interest
in the LLC. See majority op. pp. 19-20.
The majority misstates the issue. The majority writes that:
While we accept that the check-the-box regulations
govern how a single-member LLC will be taxed for
Federal tax purposes, i.e., as an association taxed as
a corporation or as a disregarded entity, we 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. * * *
Majority op. pp. 19-20. The check-the-box regulations determine
whether a single-member entity exists at all for Federal tax
purposes rather than how that entity will be taxed.
The majority distinguishes between the “classification” and
the “valuation” of an entity. But that distinction is false. The
gift tax regulations provide guidance on how to value interests in
a corporation, a partnership, and a proprietorship. See secs.
25.2512-2 and 25.2512-3, Gift Tax Regs. They do not provide
guidance on how to value an interest in a single-member LLC.
- 58 -
Accordingly, we must first “classify” the entity, and only then
can we “value” its interests. I submit that the ambiguity of
section 7701 extends to gift tax valuation. The majority cannot
trivialize the check-the-box regulations by dismissing them as
irrelevant.
III. The Majority’s Reliance on the Gift Tax Regime
The majority concludes that it would be manifestly
incompatible with the gift tax regime if we did not respect Pierre
LLC for gift tax purposes because New York law provides that a
member has no interest in specific property of the LLC while a
membership interest in an LLC is personal property. N.Y. Ltd.
Liab. Co. Law sec. 601 (McKinney 2007). I disagree. The check-
the-box regulations provide the Federal tax consequences of what
is, in effect, an agreement between the taxpayer and the
Commissioner to treat an entity in a certain way for Federal tax
purposes despite the entity’s State law classification. There is
simply no LLC interest left to value for Federal gift tax purposes
when a single-member LLC elects to be disregarded. It therefore
does not matter whether State law recognizes an LLC as a valid
entity or provides that a member has no interest in any of the
specific property of the LLC. See sec. 301.7701-1(a)(1), Proced.
& Admin. Regs. The check-the-box regulations specifically say
that Federal law determines whether a single-member entity is
recognized as separate from its owner. Id.
- 59 -
The majority dismisses relevant precedent from two Federal
Courts of Appeals addressing this conflict between State law
rights of single-member LLC owners and the consequences of
disregarded entity status under the check-the-box regulations.
See McNamee v. Dept. of the Treasury, 488 F.3d 100 (2d. Cir.
2007); Littriello v. United States, 484 F.3d 372 (6th Cir. 2007).
The Court of Appeals for the Second Circuit rejected a taxpayer’s
argument that he was not liable for his single-member LLC’s unpaid
payroll taxes because Connecticut law provided that the owner is
not personally liable for the LLC’s debts. See McNamee v. Dept.
of the Treasury, supra. The court noted that, while State laws of
incorporation control various aspects of business relations, they
may affect, but do not necessarily control, the application of
Federal tax provisions. Id. at 111 (quoting Littriello v. United
States, supra at 379). Accordingly, a single-member LLC is
entitled to whatever advantages State law may extend, but State
law cannot abrogate its owner’s Federal tax liability. Id.
The majority minimizes this relevant analysis in McNamee and
Littriello. The majority summarily concludes that it is not
relevant because the courts did not specifically address gift tax.
See majority op. p. 15. The courts had no reason to address gift
tax issues. That does not mean, however, that the courts’
analyses should be ignored.
- 60 -
Both the McNamee and Littriello courts recognized that the
check-the-box regulations applied equally to the nonincome-tax
issue of employment tax liability. Determining an owner’s
liability for employment taxes is as far removed from determining
the owner’s income tax liability as is determining the owner’s
gift tax liability. The Code imposes both Federal employment tax
liability and Federal gift tax liability separate and apart from
determining a taxpayer’s income tax liability. The majority fails
to recognize that the single owner’s liability for employment
taxes turns upon disregarding the LLC for Federal tax purposes
rather than upon the identity of the taxpayer. See Med. Practice
Solutions, LLC v. Commissioner, 132 T.C. at __ (slip op. at 5) (a
single-member LLC “and its sole member are a single taxpayer or
person to whom notice is given”); see also McNamee v. Dept. of the
Treasury, supra at 111 (an entity disregarded as separate from its
owner “cannot be regarded as the employer”); Littriello v. United
States, supra at 375, 378 (recognizing a single owner as the
individual who “owns all the assets, is liable for all debts, and
operates in an individual capacity”). Despite the majority’s
wish, Pierre LLC does not exist apart from petitioner for gift tax
purposes, and petitioner should be treated as holding its assets.
Further, the Second and Sixth Circuit Courts of Appeals
stressed that the taxpayer could have escaped personal liability
for the LLC’s tax debt if the taxpayer had simply elected
- 61 -
corporate status for the single-member LLC. McNamee v. Dept. of
the Treasury, supra at 109-111; Littriello v. United States, supra
at 378. The same principle applies here. Petitioner could have
elected to treat Pierre LLC as a corporation. She did not. The
Supreme Court has repeatedly recognized that “while a taxpayer is
free to organize his affairs as he chooses, nevertheless, once
having done so, he must accept the tax consequences of his choice,
whether contemplated or not.” Commissioner v. Natl. Alfalfa
Dehydrating & Milling Co., 417 U.S. 134, 149 (1974). I would hold
petitioner to her choice.
Finally, the majority overlooks the broad scope of the gift
tax statutes in concluding that the check-the-box regulations are
manifestly incompatible with the gift tax regime. Congress
intended to use the term “gifts” in its most comprehensive sense.
Commissioner v. Wemyss, 324 U.S. 303, 306 (1945). The gift tax
applies whether the gift is direct or indirect. Sec. 2511.
Accordingly, transfers of property by gift, by whatever means
effected, are subject to Federal gift tax. Dickman v.
Commissioner, 465 U.S. at 334. Moreover, we have used substance
over form principles to get to the true nature of the gift where
the substance of a gift transfer does not fit its form. See Kerr
v. Commissioner, 113 T.C. 449, 464-468 (1999), affd. on another
issue 292 F.3d 490 (5th Cir. 2002); Astleford v. Commissioner,
T.C. Memo. 2008-128; Estate of Murphy v. Commissioner, T.C. Memo.
- 62 -
1990-472. We have also used the step transaction doctrine, which
has been called “‘well-established’” and “‘expressly sanctioned’”
in the area of gift tax where intra-family transactions often
occur. See Senda v. Commissioner, 433 F.3d 1044, 1049 (8th Cir.
2006) (quoting Commissioner v. Clark, 489 U.S. 726, 738 (1989)),
affg. T.C. Memo. 2004-160. The majority would instead have us
apply the opposite approach, accepting petitioner’s own label
rather than the substance of her choice.
Despite this broad expanse of gift taxes, the majority would
require Congressional action before any State law property right
could be disregarded for Federal gift tax purposes. See majority
op. pp. 20-21. The majority cites four special valuation statutes
(sections 2701-2704) to imply that Congress will take action when
necessary to overcome the “willing buyer, willing seller” gift tax
valuation rule. See majority op. p. 21. I know of no authority,
however, that prevents the promulgation of regulations affecting
the so-called gift tax regime.
IV. Conclusion
The plain language of the regulations requires Pierre LLC to
be “disregarded as an entity separate from its owner.” Unlike the
majority, I give meaning to these words. I do not minimize this
language by labeling it a classification. A plain language
interpretation of the check-the-box regulations must prevail. It
- 63 -
is an interpretation of relevant regulations. It is not
manifestly incompatible with the gift tax statutes.
For the foregoing reasons, I respectfully dissent.
COLVIN, HALPERN, GALE, HOLMES, and PARIS, JJ., agree with
this dissenting opinion.