• Sale of partnership assets to disqualified person not self-dealing—In Private Letter Ruling 201510050 (March 6, 2015), the Internal Revenue Service ruled that the sale of assets by a partnership (the partnership), partly owned by a private foundation (PF), to a disqualified person (DP) wouldn’t be an act of self-dealing under Internal Revenue Code Section 4941.
The partnership owned 6,000 acres of wetlands. A PF owned a 49.9 percent interest in the partnership. DP owned a 0.1 percent interest. DP’s sister (Sister) owned a 3.56 percent interest, and a foundation to which Sister was a substantial contributor owned the remaining 46.44 percent. DP and Sister were partners in several other partnerships owning a total of 16,000 acres of land (including the wetlands owned by the partnership). To end years of contentious litigation between DP and Sister about use of the land, a court ordered the liquidation of the partnerships and sale of their land at public auction. DP wanted to purchase the land.
The IRS concluded that the sale wouldn’t result in self-dealing. Self-dealing includes sales or exchanges between: (1) an organization “controlled” (as defined in Treasury Regulations Section 53.4941(d)-1(b)(5)) by a PF, and (2) a DP. Here, the PF doesn’t control the partnership because the PF and DP can’t require the partnership to participate in the sale. Neither the PF (49.9 percent) nor DP (0.1 percent) could force the sale on their own. Combined, the PF and DP have a 50 percent interest. The repeated disputes between DP and the PF on the one hand and Sister and her foundation on the other (owning the other 50 percent), demonstrate that DP and the PF can’t control the partnership. (Although interests of DP’s “family members” would be aggregated with his interest, Sister’s interest wouldn’t be included because she’s not a family member under IRC Section 4946.)
The IRS also pointed to good facts that show the sale would be an arm’s length transaction not controlled by the PF: (1) the sale is court-ordered, (2) the sale will be conducted through neutral third-party government officials by auction, and (3) Sister and her foundation, who together will receive half of the proceeds, will seek the highest price for the land.
• Gifts qualify for annual exclusion despite in terrorem clause—In Mikel v. Commissioner, T.C. Memo. 2015-64, the Tax Court ruled that gifts to an irrevocable trust qualified for the annual gift tax exclusion despite the trust’s in terrorem clause.
Israel and Erna Mikel created an irrevocable inter vivos trust for their descendants and their descendants’ spouses. The trust gave each beneficiary the right to withdraw up to the annual exclusion amount under IRC Section 2503(b). The trust also allowed the trustees to make distributions to beneficiaries “in their sole and absolute discretion.” The trust required all disputes regarding interpretation of the trust to be resolved by a “beth din” (a rabbinical court that decides questions based on Orthodox Jewish law). If a beneficiary participated in “any proceeding to oppose the distribution” of the trust or challenged any trust distribution in a court, then the beneficiary would be “cut out” of the trust.
The Mikels claimed that a portion of their 2007 gifts to the trust qualified for the gift tax annual exclusion. The IRS determined that the gifts were ineligible for the annual exclusion because the beneficiaries didn’t have a present interest in the contributed property due to the requirement of submitting disputes to the beth din and because of the in terrorem clause. The IRS argued that the withdrawal rights were illusory because if the trustee refused to honor them, the beneficiaries would need to go to the beth din, and if the beth din sided with the trustee, the beneficiaries would be reluctant to go to court because doing so could trigger the in terrorem clause and cut them out of the trust.
Using the test from Crummey1 and Christofani,2 the Tax Court rejected the IRS’ arguments and concluded that the beneficiaries had present interests because their withdrawal rights couldn’t be “legally resisted” by the trustees. Even assuming the withdrawal rights had to be legally enforceable in addition to being legally irresistible, the Tax Court stated:
. . . it is not obvious why the beneficiary must be able to ‘go before a state court to enforce that right.’ Here, if the trustees were to breach their fiduciary duties by refusing a timely withdrawal demand, the beneficiary could seek justice from a beth din, which is directed to ‘enforce the provisions of this Declaration * * * and give any party the rights he is entitled to under New York law.’
Further, the court interpreted the in terrorem clause to relate to challenges to the trust’s discretionary distributions, not to the beneficiaries’ withdrawal rights: A challenge to enforce a withdrawal right wouldn’t be a proceeding to oppose or challenge a distribution from the trust. The in terrorem clause, therefore, wouldn’t deter the beneficiaries from enforcing their withdrawal rights. Thus, the withdrawal rights constituted present interests, and the gifts qualified for the gift tax annual exclusion.
1. Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968).
2. Christofani v. Comm’r, 979 T.C. 74 (1991).