IRS Disregards Trust Scheme when Intent Says Otherwise
A significant tax court case involving a trust scheme demonstrates why the IRS successfully challenged a gift of LLC interests – and why proper documentation and adherence to corporate formalities are critical in estate planning, especially when family members are involved.
The Case
The case involved a husband transferring LLC interests to his wife, who held them for only one day before transferring them to a dynasty trust created to benefit the husband’s children from a previous marriage. The husband was not required to report the spousal gift, and the wife’s reported transfer fell within her lifetime exemption, so no gift taxes appeared to be due.
However, the IRS assessed a $1.154 million gift tax deficiency – which the tax court upheld.
Red Flags the Court Identified
Timing Issues
The wife committed to transferring the shares before even receiving them and held the interest for merely one day. This extremely hasty timeline raised questions about the legitimacy of the transaction.
Lack of Formal Recognition
The husband, who controlled the LLC, failed to amend LLC documents to reflect his wife’s membership. She remained an assignee rather than a member, despite receiving an assignment of interest.
Deficient Documentation
Court records included undated documents and others with “effective dates” but no signing dates, which the court found unbelievable.
The Legal Principle: Substance Over Form
The tax court applies the doctrine of “substance over form” – the actual substance of a transaction determines tax treatment, not merely its presentation. The IRS particularly scrutinizes transactions involving family members to verify legitimacy.
Lessons for Estate Planning
When creating entities, transferring interests, or establishing trusts, consistency and adherence to all procedural requirements are essential. An experienced estate planning attorney does more than draft documents; they educate clients on proper execution to withstand IRS scrutiny.
The mistakes in this case far outweighed any benefits gained.
If you or a loved one needs assistance with estate planning issues, do not hesitate to contact The Stegall Law Firm for guidance.
