IRS Wins Again on Annual Exclusion of Gifts of Partnership Interests

By Eric L. Johnson, CPA, CFP, MST, Craig L. Janes, CPA


  • The Tax Court in Hackl for the first time specifically denied that the mere transfer of a partnership interest automatically qualifies as a gift of a present interest qualifying the transfer for the gift tax annual exclusion. The court required the taxpayer to establish that the transfer in dispute conferred on the donee an unrestricted and noncontingent right to the immediate use, possession, or enjoyment of property or of income from property.
  • In Price, the Tax Court again applied the substantial present economic benefit rationale. Because the donees received only an assignee interest, they lacked the ability to withdraw their capital accounts, to sell, assign, or transfer their partnership interests to third parties, or to encumber or dispose of the interests without the written consent of all the partners.
  • In Fisher, the IRS has again won on this point. The court concluded the taxpayers’ transfers of partnership interests to their children were not transfers of present interests in property and therefore did not qualify for the gift tax annual exclusion.
  • Based on the lessons from these cases, several planning ideas can help taxpayers defend against a challenge that transfers of partnership interests do not qualify as a present interest.

In April 2010, The Tax Adviser reported on the Price case, 1 which reinforced the IRS’s position in Hackl. 2 In that case, the taxpayers failed to show that gifts of partnership interests conferred on the donees an unrestricted right to immediately use, possess, or enjoy either the property itself or income from the property. Thus, the transfers in question were not considered present interest gifts, and the taxpayers were not entitled to gift tax annual exclusions. The Fisher case 3 now follows as the most recent IRS victory on this issue. This article reviews what can be learned from Fisher, the challenge that tax practitioners now face in existing arrangements, and responsive measures that might be considered for further gifts of partnership interests.


Current law allows an individual who wants to make a gift to transfer up to $13,000 per donee, per calendar year, free of gift tax and without the requirement of filing a gift tax return. 4 In order to qualify for this annual exclusion, however, the gift must be of a present interest in property. The Code does not define “present interest,” but Treasury regulations provide that a present interest is “an unrestricted right to the immediate use, possession, or enjoyment of property or the income from property (such as a life estate or term certain).” 5

Hackl was the first case to specifically deny the premise that the mere transfer of a partnership interest automatically qualifies as a present interest and thus qualifies the transfer for the gift tax annual exclusion. The Tax Court in Hackl interpreted the regulatory definition to require the taxpayer to

establish that the transfer in dispute conferred on the donee an unrestricted and noncontingent right to the immediate use, possession, or enjoyment (1) of property or (2) of income from property, both of which alternatives in turn demand that such immediate use, possession, or enjoyment be of a nature that substantial economic benefit is derived therefrom. 6

A transfer needs to meet only the use test or the income test to demonstrate a substantial present benefit and thus qualify as a present interest.

In Price, the Tax Court again applied the substantial present economic benefit rationale. The court noted that, similar to Hackl, because the donees received only an assignee interest, they lacked the ability to withdraw their capital accounts, to sell, assign, or transfer their partnership interests to third parties, or to encumber or dispose of the interests without the written consent of all the partners. Further, the partnership’s earnings, which were distributable at the general partner’s discretion, did not flow consistently or predictably to the partners because in some years no distributions were made. Consequently, the court noted that the donees lacked the ability “presently to access any substantial economic or financial benefit that might be represented by the ownership of units,” 7 and the gift tax annual exclusion was again denied.


In each of the years 2000, 2001, and 2002, John and Janice Fisher (the Fishers) transferred a 4.762% membership interest in Good Harbor Partners, LLC (Good Harbor) to each of their seven children, in effect transferring the entire LLC to their children over this three-year period. During the years that the gifts were made, the LLC’s principal asset was a parcel of undeveloped land that bordered Lake Michigan.

A few provisions in the Good Harbor operating agreement are worth mentioning:

  • The agreement provided for the LLC to be managed by a management committee that would appoint a general manager, and that manager would determine the timing and amount of all distributions. The Fishers constituted the management committee, and Mr. Fisher was appointed as the general manager.
  • The Fisher children were allowed to transfer their interests in the LLC if certain conditions were satisfied. The operating agreement defined “interest” as “a Person’s share of the Profits and Losses of, and the right to receive distributions from, the Company,” and further provided that this was the only interest that the Fisher children could transfer unilaterally.
  • Should a transfer to a nonfamily member be contemplated, the LLC had a right of first refusal for a 30-day period, followed by a 40- to 90-day period to set a closing date. At closing, the LLC would pay the prospective transferor with self-amortizing, nonnegotiable promissory notes, payable over a period not to exceed 15 years. The right of first refusal could be disregarded if the contemplated transfer was to a family member.

When the Fishers filed their annual gift tax returns, they claimed a gift tax annual exclusion for each transfer. Upon audit, the IRS disputed the value of the transferred interests and disallowed the annual exclusions on the basis that the gifts were not present interests and therefore did not qualify. The total gift tax deficiency assessed over the three-year period was $625,986. Choosing to forgo a direct challenge of Hackl in Tax Court, the Fishers paid the deficiency and filed for refund, asserting, among other things, that the gifts of membership interests were gifts of present interests that qualified for the gift tax annual exclusion. The refund was denied, and the Fishers filed suit in federal district court. The court ruled on cross motions for summary judgment in which the single issue was whether the gifts the Fishers made “to their children were transfers of present interests in property and, therefore, qualified for the gift tax exclusion under 26 U.S.C. § 2503(b)(1).” 8

The Fishers presented three arguments in support of their claim, all of which the court rejected:

  1. The Fisher children had an unrestricted right to receive distributions from the LLC. However, the court noted that the timing and amount of any distributions were “within the exclusive direction of the General Manager” of the LLC, and as such the right to any distributions “is not a right to a ‘substantial present economic benefit’” as required in Hackl. 9
    Observation: With Mr. Fisher appointed as the general manager and in control of the timing, amount, and character of all distributions, this determination appears to be consistent with the decisions in Hackl and Price, where general manager discretion over distributions was likewise deemed problematic. Interestingly, the fact that the partnership’s asset was unproductive, undeveloped land did not enter into the determination.
  2. The Fisher children had the unrestricted right to use the lakefront parcel that was the primary asset of the LLC. The court noted that there was no evidence in the operating agreement that the right to use the land was transferred with the member interests. Further, the court stated that even if the land-use rights were transferred with the member interests, such rights alone were not a substantial present economic benefit but merely “a non-pecuniary benefit.” 10
    Observation: The unanswered question is under what circumstances the right to use and enjoy the LLC’s assets would rise above a nonpecuniary benefit and meet the substantial present economic benefit requirement set forth in Hackl. Was this an issue because the real estate was undeveloped? In stating that the mere right to use property does not result in a substantial present economic benefit, the court appears to contradict analogous existing authority with respect to below-market loans. 11
  3. The Fisher children had the unrestricted unilateral right to transfer their interests. The operating agreement for Good Harbor did provide for the free transferability of interests by the donee subject to the right of first refusal as set forth above. However, the court stated that this “effectively prevents the Fisher Children from transferring their interests in exchange for immediate value unless the transfer is to one of the Fisher’s descendants,” and even so “a transfer to a family member is not without restrictions.” 12
    Observation: One hopes that it was not the existence of the right of first refusal that was the issue but rather the 30-day and 40- to 90-day response periods, and/or the LLC’s right to pay with a long-term, 15-year note that underpinned the court’s determination that no donee enjoyed a substantial present economic benefit.

The court concluded, based upon the undisputed facts, that the Fishers’ transfers of Good Harbor interests to the Fisher children were not transfers of present interests in property and therefore did not qualify for the gift tax annual exclusion. Accordingly, the court granted the government’s motion for summary judgment and denied the taxpayers’ cross motion.

Gift Tax Return Preparation

In prior years, it was reasonably assured that an outright transfer of a limited partnership or LLC interest qualified for the gift tax annual exclusion. 13 However, a more critical review is now warranted for any subsequently filed gift tax returns.

Both the taxpayer (in the context of the accuracy-related penalties 14) and the tax return preparer (in the context of the newly revised preparer penalty provisions 15) are required to meet a “substantial authority” standard to take a position on a tax return without further disclosure. However, with proper disclosure of the tax position on a Form 8275, Disclosure Statement, attached to the return, this minimum standard is lowered to a “reasonable basis” threshold. 16

For both the taxpayer and the tax preparer, the analysis of whether the gift of a partnership interest qualifies as a present interest in property requires:

  • A review of the partnership or LLC operating agreement provisions and comparison with the facts in the recent cases; and
  • A determination as to the level of authority regarding the position.

A taxpayer and his or her tax preparer may find it helpful to consult with counsel prior to taking a position on the gift tax return.

A secondary reporting concern is whether the failure to disclose a potentially assailable gift tax annual exclusion might somehow put into question the closing of the gift tax statute of limitation. As a practical matter, many taxpayers who only make gifts within the amount of the annual exclusion per donee do not file gift tax returns. In those cases, the statute of limitation clearly will not begin to run. 17 For taxpayers who do file gift tax returns for these transfers, however, the running of the statute of limitation is not necessarily guaranteed. Since 1997, the Code has provided that the gift tax statute of limitation for any transfer will close with respect to that transfer only if it is adequately disclosed. 18 Thus, if a taxpayer files a gift tax return to report gifts within the annual exclusion amount but fails to provide required information, the statute of limitation will not begin to run for those transfers.

The regulations provide that a transfer will be adequately disclosed on the return only if it is reported in a manner adequate to apprise the IRS of the nature of the gift and the basis for the value so reported. 19 Transfers reported on the gift tax return will be considered adequately disclosed if the return (or a statement attached to the return) provides certain information. The IRS might assert that the failure to describe the circumstances upon which the taxpayer relies in order to obtain the annual exclusion may permit the IRS to argue that the statute of limitation for such transfers did not close at the end of the normal three-year period. If a taxpayer fails to disclose the rationale for claiming the annual exclusion but otherwise complies with the adequate disclosure regulations for a gift of a partnership or LLC interest, the application of the indefinite statute of limitation would likely turn upon the requirement that the taxpayer disclose any position that was contrary to a Treasury regulation or revenue ruling published at the time of the transfer. 20 This question was not addressed in Fisher because the audit of all the Fisher transfers occurred within the limitation period, which was probably extended by agreement.

Planning Implications

In the Fishers’ (and Prices’) defense, the families and their advisers did not have the full benefit of the 2002 Hackl decision when the respective gifts in both cases were made in 2000–2002. However, even after the Hackl decision, many practitioners viewed Hackl as an outlier and did not take specific action to address any present interest concerns potentially embedded in current operating agreements. However, with both Price and Fisher surfacing in 2010, a more careful review of existing agreements appears to be warranted.

The Fisher decision, in particular, challenges practitioners, given the prevalence of rights of first refusal in existing family partnership and LLC agreements, particularly because the existence of such controls is due fundamentally to the nontax purpose of keeping family control over strategic assets. Equally troubling, such controls have assisted in the defense against Sec. 2036 attacks by the IRS. 21 It would be unfortunate if the nontax justification of maintaining family control was found to be antithetical to and mutually exclusive of qualifying transfers in such entities for the gift tax annual exclusion. Whether Fisher stands for that proposition is not clear. In any event, for current operating agreements with rights of first refusal, practitioners will need to consider whether modifications to that arrangement are warranted.

In addition, practitioners will need to be comfortable that transfers convey a substantial present economic benefit by meeting either the use or income tests as set forth in Hackl. The Fisher decision is particularly unclear as to what conditions are required to meet the use test for nonincome-producing property. Furthermore, based on the outcome in Price, in order to meet the income test it appears that mandatory annual distributions might be required in the operating agreement. One can expect the IRS to challenge any distribution policy that appears to call for only immaterial distributions. Of course, meeting the income test through consistent, annual, material distributions may be a double-edged sword, since empirical evidence suggests that larger distributions result in a lower marketability discount for such interests. 22

Proposed Responsive Measures

The focus now shifts to prospective transfers of limited partnership or LLC interests. In light of these recent IRS victories, several ideas have surfaced to defend against any challenge that such transfers do not qualify as a present interest. A noncomprehensive list is provided here.

Required Partnership Distributions

In an effort to satisfy the income test consistent with the Hackl and Price decisions, consider including in the operating agreement a requirement that excess cashflow be distributed annually, subject to a floor equal to the amount required to pay taxes on partnership income plus some limited but non–de minimis amount. Arguably, the net present value of this non–de minimis amount should be greater than the annual exclusion amount in order to avoid the assertion that tax distributions alone are insufficient to provide a substantial present economic benefit. Such a requirement serves other useful purposes as well when combating a Sec. 2036 inclusion argument with respect to the partnership or LLC. 23 Note, however, that such a program may adversely affect any valuation discounts that may be prospectively applied to any transfers.

Withdrawal Right Feature

This idea borrows the Crummey 24 withdrawal right concept commonly used in trust planning to qualify certain transfers in trust for the gift tax annual exclusion. Consider including in the operating agreement a right for a donee, for a limited time after receipt of the partnership interest, to make a limited withdrawal from his or her capital account of an amount equal to the lesser of the value of the transferred interest or the amount of the gift tax annual exclusion. Such a withdrawal right would reduce the partner’s respective capital account but would not otherwise affect either the partner’s capital ownership or profit/loss sharing ratios.

At first blush, such a withdrawal right would appear to present certain risks under the special valuation rules of chapter 14. For example, because the right is preferential in nature, might it be considered a senior equity class subject to Sec. 2701? 25 But on further reflection, because the right appends itself to a transferred interest, it could never be an applicable retained interest and thus, all other things being equal, would be removed from the architecture of Sec. 2701. 26

Outside of chapter 14, might one argue that the lapse of the withdrawal right gives rise to a result not unlike those dictated by Sec. 2514(e) upon the lapse of a general power of appointment in excess of the 5%/$5,000 threshold? This argument, too, falls to reason. Specifically, as long as a partner’s entitlement on termination or dissolution of the partnership is to distributions from the partnership in amounts equal to his or her respective capital account, no transfer can have occurred until such time as the capital account is reduced by an assignment. It is this same rationale that, in part, prevents a gift at inception argument when a partnership or LLC is established. 27 If such is the case, the lapse of the withdrawal right is one of timing and is therefore an incomplete transfer, rather than a permanent transfer of value to the other partners.

Liquidation Right Feature

Consider including in the operating agreement an option for the donee, for a limited time after receipt of the partnership interest, to put some or all of the transferred interest to the partnership or LLC for an amount up to the value of the gift tax annual exclusion. The amount of the interest in the partnership or LLC to put would be determined by reference to the appraisal that governed the gift transfer to which the put option applies. While clearly giving rise to a substantial present economic benefit, this idea differs from the withdrawal right above because it involves surrendering some or all of the interest received by gift for cash at the election of the donee. Thus, if exercised, the liquidation right would reduce the capital and profit/loss sharing ratios as well as the capital account of the donee.

Unlike the withdrawal right, however, the liquidation right has more compelling chapter 14 issues. Specifically, it implies a buy-sell arrangement between the entity and the donee partner that would appear to fall subject to Sec. 2703 (discussed further below). In addition, because such a right is clearly a Sec. 2704 liquidation right, 28 its lapse is likely to be considered a gift to the donee’s fellow partners equal to the value differential of the subject property before and after the lapse. 29 What is unclear is whether the lapse of the liquidation right might also be considered an incomplete transfer based on the same rationale as described above for the withdrawal right. In this context, it is worth noting that the limited legislative history and case law with respect to chapter 14 have characterized it as creating special rules for the valuation of transfers (as opposed to redefining what a transfer is). While such an argument has merit, Sec. 2704 appears to imply that the lapse is itself a completed transfer to which the gift tax rules must be applied. 30

Put Right Provision

In another version of the liquidation right feature, consider having the partnership agreement grant a donee partner a put right that would require one or more other partners to purchase the transferred entity interest for fair market value. If exercised, the cross-purchase option would reduce the capital ownership percentage and profit/loss sharing ratios as well as the capital account of the donee. Such a right has the advantage of conveying a substantial present economic benefit but avoids some of the baggage that appends a liquidation right under Sec. 2704. However, it shares a common chapter 14 concern with that of the liquidation right. It implies a buy-sell arrangement—in this case a cross-purchase agreement between the partners—that would appear to fall subject to Sec. 2703. Luckily, however, because the buy-sell agreement in either case would be governed by the determination of fair market value used in the original gift and there is no attempt to impose a value other than fair market value, Sec. 2703 cannot apply. 31

All the above suggestions appear, at face value, to meet the test of conveying a substantial present economic benefit to a donee. Regardless of the measure chosen, any legally enforceable right by the donee to realize immediate value should go a long way to qualifying the transfer as a present interest and thus the gift tax annual exclusion. However, it is equally true that the IRS will scrutinize such arrangements carefully (e.g., as they have Crummey withdrawal powers) and may well prevail where the facts suggest that the substantial present economic benefit is more illusion than reality. Nevertheless, the presence of terms like those discussed above forms a basis for a determination that substantial authority exists to claim the annual gift tax exclusion.


Given the IRS’s recent momentum on this issue and the colorful history of challenging family partnership or LLC arrangements, it is certainly possible that additional cases will be forthcoming on this matter. Tax practitioners with family partnerships or LLCs as clients are well advised to review current family partnership or LLC arrangements, particularly in situations where gifts of interests have been made or are contemplated to be made. If a current arrangement causes concern, the impact on any current gift tax return filings should be addressed, and prospective measures should be considered before any additional transfers are contemplated.

This publication contains general information only, and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional adviser. Deloitte, its affiliates, and related entities shall not be responsible for any loss sustained by any person who relies on this publication.

Authors’ note: The authors thank Ryan Thomas for his contributions to this article.


1 Price, T.C. Memo. 2010-2. See Deering, “IRS Continues Focus on Disallowing Annual Exclusions for Gifts of Partnership Interests,” 41 The Tax Adviser 234 (April 2010).

2 Hackl, 118 T.C. 279 (2002), aff’d, 335 F.3d 664 (7th Cir. 2003).

3 Fisher, No. 1:2008cv00908 (S.D. Ind. 3/11/10).

4 Secs. 2503(b) and 6019(a)(1).

5 Regs. Sec. 25.2503-3(b).

6 Hackl, 118 T.C. at 293.

7 Price, T.C. Memo. 2010-2 at 14, quoting Hackl, 118 T.C. at 296.

8 Fisher, slip op. at 1.

9 Id. at 5, quoting Hackl, 335 F.3d at 667.

10 Fisher, slip op. at 6.

11 Rev. Rul. 73-61, 1973-1 C.B. 408; Sec. 7872; Dickman, 465 U.S. 330 (1984).

12 Fisher, slip op. at 7.

13 See, e.g., IRS Technical Advice Memorandum 199944003 (11/5/99), in which the annual exclusion was allowed for a fairly “standard” family limited partnership interest.

14 Sec. 6662 and Regs. Sec. 1.6662-4(a).

15 Sec. 6694 and the corresponding Treasury regulations.

16 Regs. Secs. 1.6662-3(c), 1.6662-4(e) and (f), and 1.6694-2(d).

17 Sec. 6501(c)(3).

18 Sec. 6501(c)(9).

19 Regs. Sec. 301.6501(c)-1(f)(2).

20 Regs. Sec. 301.6501(c)-1(f)(2)(v). Note that the court cited Regs. Secs. 25.2503-3(a) and (b) in its determination that the transfers did not constitute present interests.

21 See Estate of Schutt, T.C. Memo. 2005-126; Estate of Black, 133 T.C. No. 15 (2009).

22 See, e.g., Bajaj et al., “Firm Value and Marketability Discounts,” 27 J. Corp. L. 89 (2001).

23 Specifically, by eliminating the discretion of the general partner or LLC manager with respect to distributions, there is arguably a lesser risk that the decedent had the right to designate the persons who possess or enjoy the entity property or income within the meaning of Sec. 2036(a)(2). See also Estate of Mirowski, T.C. Memo. 2008-74.

24 Crummey, 397 F.2d 82 (9th Cir. 1968).

25 Regs. Sec. 25.2701-3(a)(2)(ii).

26 Regs. Sec. 25.2701-1(a)(2).

27 See, e.g., Kimbell, 371 F.3d 257 (5th Cir. 2004).

28 Regs. Sec. 25.2704-1(a)(2)(v).

29 Regs. Sec. 25.2704-1(d). This assumes that the members of the option holder’s family control the partnership or LLC both before and after the expiration of the right.

30 Regs. Sec. 25.2704-1(c).

31 Regs. Sec. 25.2703-1(a)(2).


Eric L. Johnson is a partner in the Chicago office of Deloitte Tax L LP and a member of the AICPA ’s Trust, Estate & Gift Tax Technical Resource Panel. Craig Janes is a partner in the Washington, DC, office of Deloitte Tax LLP. For more information about this article, contact Mr. Johnson at

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