The “Disregarded Multi-Member Limited Liability Company” as A Gifting Vehicle

A “disregarded multi-member limited liability company” (“Disregarded MM LLC”) is a multi-member limited liability company for state law purposes but is disregarded as an entity separate from its owner for federal income tax purposes. All of the members of the Disregarded MM LLC are grantor trusts, with the same individual senior family member (“Senior”) serving as grantor of all such grantor trust members. One such trust member might be Senior’s revocable trust, and the other trust members might be intentionally defective grantor trusts established by Senior for the benefit of his children or grandchildren (“Lineal Trusts”).

From a cost savings perspective, this structure allows a client to avoid filing an annual federal income tax return for the Disregarded MM LLC. Further, the use of the “disregarded entity” adds significant value to the structure through enhanced asset protection and the opportunity to utilize valuation discount principles in making the gifts. In addition, the forgoing structure achieves income tax neutrality because the Disregarded MM LLC’s existence is ignored for federal income tax purposes. Similarly, because the Lineal Trusts are income tax defective, their existence is ignored for federal income tax purposes, and because the grantor bears the federal income tax burden with respect to the Lineal Trusts, the growth of the assets contained in such trusts is accelerated.

A wide variety of assets could be contributed by Senior to the Disregarded MM LLC to set the stage for tax planning involving the utilization of lifetime gift tax credit. The following example illustrates the potential of the Disregarded MM LLC for making gifts in a scenario where an entity classified as a partnership for federal income tax purposes could not be utilized.

Senior is the grantor and sole lifetime beneficiary of a revocable trust (the “Revocable Trust”), which Revocable Trust owns one or more installment sale notes receivable (the “Notes”). Senior forms a single member limited liability company under Florida law (the “LLC”), contributing the Notes to the LLC in exchange for 100% of the membership interests. The LLC is comprised of 100 Class A Voting Units and 9,900 Class B Non-voting Units (the “Non-Voting Units”). For federal income tax purposes, the LLC is disregarded as an entity separate from its owner unless the LLC elects to be treated otherwise. The LLC has not made such an election.

Senior establishes three (3) Lineal Trusts with Senior as the grantor. The beneficiary of each of the Lineal Trusts is one of Senior’s children. Senior transfers by gift one-third (1/3) of the Non-Voting Units to each of the Lineal Trusts in exchange for a membership interest in the LLC. The LLC is now a multi-member limited liability company for state law purposes but for federal income tax purposes is disregarded as an entity separate from its owner. The Lineal Trusts now own 99% of the LLC.

In general, a gift of an installment sale note receivable – including a gift of a partnership interest in a partnership holding installment notes receivable — is treated as a disposition made other than a sale, exchange, or satisfaction at face amount, in which case the donor immediately recognizes a gain in an amount equal to the spread between the fair market value of the note on the date of the gift and the adjusted basis of the donor in the installment note receivable. However, the transfer of an installment note receivable to and from a grantor trust is not a taxable disposition. Similarly, the transfer of an installment note receivable from a grantor trust to a disregarded entity wholly owned by the grantor should not be a taxable disposition. Thus, neither the contribution of the Notes by Senior to the LLC, nor the gifts of the Non-Voting Units by Senior to the Lineal Trusts, should result in an acceleration of the Notes under the installment sale rules.

Again, the use of the “disregarded entity” adds significant value to the structure through enhanced asset protection and the opportunity to utilize valuation discount principles in making the gifts. In addition, the forgoing structure achieves income tax neutrality because the LLC’s existence is ignored for federal income tax purposes. Similarly, because the Lineal Trusts are income tax defective, their existence is ignored for federal income tax purposes. Thus, Senior is deemed to be transacting with himself, and the whole series of transactions should be ignored for income tax purposes under the theory of Rev. Rul. 85-13. However, the advisor must be careful to ensure sure that (i) the LLC retains its status as a “disregarded entity”; and (ii) the Lineal Trusts retain their status as “intentionally defective grantor trusts” at all times prior to the complete satisfaction of the Notes.
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Rev. Rul. 2004-77, 2004-31 I.R.B. 119 (8/2/2004); Regs. Section 301.7701-2(a)(providing that (i) a business entity is any entity recognized for federal tax purposes (including an entity with a single owner that may be disregarded as an entity separate from its owner under Regs. Section 301.7701-3) that is not properly classified as a trust under Regs. Section 301.7701-4 or otherwise subject to special treatment under the Code; (ii) a business entity with two or more owners is classified for federal tax purposes as either a corporation or a partnership; (iii) a business entity with only one owner is classified as a corporation or is disregarded); Regs. Section 301.7701-2(c)(1) (providing g that, for federal tax purposes, the term “partnership” means a business entity that is not a corporation under Regs. Section 301.7701-2(b) and that has at least two owners); Regs. Section 301.7701-2(c)(2)(i) (providing that a business entity that has a single owner and is not a corporation under Regs. Section 301.7701-2(b) is disregarded as an entity separate from its owner); Regs. Section 301.7701-3(a) (providing that (i) a business entity that is not classified as a corporation under Regs. Section 301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8) (an eligible entity) can elect its classification for federal tax purposes; (ii) an eligible entity with at least two owners can elect to be classified as either an association (and thus a corporation under Regs. Section 301.7701-2(b)(2)) or a partnership; and (iii) 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); Regs. Section 301.7701-3(b)(1)(providing that in the absence of an election otherwise, a domestic eligible entity is (a) a partnership if it has at least two members, or (b) disregarded as an entity separate from its owner if it has a single owner).

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Regs. Section 301.7701-3(b)(1)(ii). All Section references contained in this Article are to the Internal Revenue Code of 1986, as amended (the “Code”), or to the Treasury Regulations promulgated thereunder (“Regs”).
Rev. Rul. 60-352, 1960-2 CB 208 (gift of partnership interest in a partnership that held installment notes receivable resulted in acceleration of all deferred gain); Regs. Section 1.453-9(b)(2)(Holder’s basis in installment note receivable is an amount equal to the excess of the face value of the obligation over the total amount receivable by the holder if the note were completely satisfied).
Rev. Rul. 74-613, 1974-2 CB 153.